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Ch15-18

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Chapter 15 The Money Supply Process
The interest rate charged on overnight loans of reserves between banks is the
1. A) prime rate.
2. B) discount rate.
3. C) federal funds rate.
4. D) Treasury bill rate.
Answer: C
2
The primary indicator of the Fed's stance on monetary policy is
1. A) the discount rate.
2. B) the federal funds rate.
3. C) the growth rate of the monetary base.
4. D) the growth rate of M2.
Answer: B
3
The quantity of reserves demanded equals
1. A) required reserves plus borrowed reserves.
2. B) excess reserves plus borrowed reserves.
3. C) required reserves plus excess reserves.
4. D) total reserves minus excess reserves.
Answer: C
4
Everything else held constant, when the federal funds rate is ________ the interest rate paid on
reserves, the quantity of reserves demanded rises when the federal funds rate ________.
1. A) above, rises
2. B) above, falls
3. C) below, rises
4. D) below, falls
5
The opportunity cost of holding excess reserves is the federal funds rate
1. A) minus the discount rate.
2. B) plus the discount rate.
3. C) plus the interest rate paid on excess reserves.
4. D) minus the interest rate paid on excess reserves.
Answer: D
6
In the market for reserves, when the federal funds rate is above the interest rate paid on excess
reserves, the demand curve for reserves is
1. A) vertical.
2. B) horizontal.
3. C) positively sloped.
4. D) negatively sloped.
Answer: D
7
When the federal funds rate equals the interest rate paid on excess reserves
1. A) the supply curve of reserves is vertical.
2. B) the supply curve of reserves is horizontal.
3. C) the demand curve for reserves is vertical.
4. D) the demand curve for reserves is horizontal.
Answer: D
8
The quantity of reserves supplied equals
1. A) nonborrowed reserves minus borrowed reserves.
2. B) nonborrowed reserves plus borrowed reserves.
3. C) required reserves plus borrowed reserves.
4. D) total reserves minus required reserves.
Answer: B
9
In the market for reserves, when the federal funds interest rate is below the discount rate, the
supply curve of reserves is
1. A) vertical.
2. B) horizontal.
3. C) positively sloped.
4. D) negatively sloped.
Answer: A
10
When the federal funds rate equals the discount rate
1. A) the supply curve of reserves is vertical.
2. B) the supply curve of reserves is horizontal.
3. C) the demand curve for reserves is vertical.
4. D) the demand curve for reserves is horizontal.
Answer: B
11
In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, then an open market ________ the supply of reserves, raising the federal funds interest
rate, everything else held constant.
1. A) sale decreases
2. B) sale increases
3. C) purchase increases
4. D) purchase decreases
12
In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, an open market purchase ________ the ________ of reserves which causes the federal
funds rate to fall, everything else held constant.
1. A) increases; supply
2. B) increases; demand
3. C) decreases; supply
4. D) decreases; demand
Answer: A
13
In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, an open market purchase ________ the supply of reserves and causes the federal funds
interest rate to ________, everything else held constant.
1. A) decreases; fall
2. B) increases; fall
3. C) increases; rise
4. D) decreases; rise
Answer: B
14
In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, an open market sale ________ the supply of reserves causing the federal funds rate to
________, everything else held constant.
1. A) decreases; decrease
2. B) increases; decrease
3. C) increases; increase
4. D) decreases; increase
Answer: D
15
In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, an open market sale ________ the ________ of reserves, causing the federal funds rate to
increase, everything else held constant.
1. A) increases; supply
2. B) increases; demand
3. C) decreases; supply
4. D) decreases; demand
Answer: C
16
In the market for reserves, a lower discount rate
1. A) decreases the supply of reserves.
2. B) increases the supply of reserves.
3. C) lengthens the vertical section of the supply curve of reserves.
4. D) shortens the vertical section of the supply curve of reserves.
Answer: D
17
In the market for reserves, a lower interest rate paid on excess reserves
1. A) decreases the supply of reserves.
2. B) increases the supply of reserves.
3. C) decreases the effective floor for the federal funds rate.
4. D) increases the effective floor for the federal funds rate.
Answer: C
18
Everything else held constant, in the market for reserves, when the federal funds rate is 3%,
lowering the discount rate from 5% to 4%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
19
Everything else held constant, in the market for reserves, when the federal funds rate is 3%,
increasing the interest rate paid on excess reserves from 1% to 2%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
20
Everything else held constant, in the market for reserves, when the federal funds rate is 5%,
lowering the discount rate from 5% to 4%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: A
21
Everything else held constant, in the market for reserves, when the federal funds rate is 1%,
increasing the interest rate paid on excess reserves from 1% to 2%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: B
22
Everything else held constant, in the market for reserves, when the federal funds rate is 3%,
raising the discount rate from 5% to 6%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
23
Everything else held constant, in the market for reserves, when the federal funds rate is 3%,
lowering the interest rate paid on excess reserves rate from 2% to 1%
1. A) lowers the federal funds rate.
2. B) raises the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
24
Everything else held constant, in the market for reserves, when the federal funds rate equals the
discount rate, lowering the discount rate
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect of the federal funds rate.
Answer: B
25
Everything else held constant, in the market for reserves, when the federal funds rate equals the
interest rate paid on excess reserves, raising the interest rate paid on excess reserves
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect of the federal funds rate.
Answer: A
26
Everything else held constant, in the market for reserves, when the demand for federal funds
intersects the reserve supply curve along the horizontal section, increasing the discount rate
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: A
27
Everything else held constant, in the market for reserves, when the supply for federal funds
intersects the reserve demand curve along the horizontal section of the demand curve, lowering
the interest rate paid on excess reserves
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect of the federal funds rate.
Answer: B
28
Everything else held constant, in the market for reserves, when the demand for federal funds
intersects the reserve supply curve on the vertical section, increasing the discount rate
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
29
Everything else held constant, in the market for reserves, when the supply for federal funds
intersects the reserve demand curve on the downward sloping section, decreasing the interest
rate paid on excess reserves
1. A) increases the federal funds rate.
2. B) lowers the federal funds rate.
3. C) has no effect on the federal funds rate.
4. D) has an indeterminate effect on the federal funds rate.
Answer: C
30
Everything else held constant, in the market for reserves, increases in the discount rate affect the
federal funds rate
1. A) when the funds rate is below the discount rate.
2. B) when the funds rate equals the discount rate.
3. C) when the demand for federal funds intersects the vertical section of the reserve
supply curve.
4. D) when the demand for federal funds equals zero.
Answer: B
31
Everything else held constant, in the market for reserves, decreases in the interest rate paid on
excess reserves affect the federal funds rate
1. A) when the funds rate is below the interest rate paid on excess reserves.
2. B) when the funds rate equals the interest rate paid on excess reserves.
3. C) when the funds rate is below the discount rate.
4. D) when the funds rate equals the discount rate.
Answer: B
32
After 2003, The Federal Reserve usually keeps the discount rate
1. A) above the target federal funds rate.
2. B) equal to the target federal funds rate.
3. C) below the target federal funds rate.
4. D) equal to zero.
Answer: A
33
Everything else held constant, the vertical section of the supply curve of reserves is shortened
when the
1. A) discount rate increases.
2. B) discount rate decreases.
3. C) federal funds rate rises.
4. D) federal funds rate falls.
Answer: B
34
Everything else held constant, the vertical section of the supply curve of reserves is lengthened
when the
1. A) discount rate increases.
2. B) discount rate decreases.
3. C) federal funds rate rises.
4. D) federal funds rate falls.
Answer: A
35
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, an increase in the reserve requirement ________ the demand for
reserves, ________ the federal funds rate, everything else held constant.
1. A) decreases; lowering
2. B) increases; lowering
3. C) increases; raising
4. D) decreases; raising
Answer: C
36
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for
reserves, raising the federal funds interest rate, everything else held constant.
1. A) rise; decreases
2. B) rise; increases
3. C) decline; increases
4. D) decline; decreases
Answer: B
37
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a ________ in the reserve requirement increases the demand for
reserves, ________ the federal funds interest rate, everything else held constant.
1. A) rise; lowering
2. B) decline; raising
3. C) decline; lowering
4. D) rise; raising
Answer: D
38
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, an increase in the reserve requirement ________ the demand of
reserves and causes the federal funds interest rate to ________, everything else held constant.
1. A) decreases; fall
2. B) increases; fall
3. C) increases; rise
4. D) decreases; rise
Answer: C
39
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, an increase in the reserve requirement ________ the ________ for
reserves and causes the federal funds interest rate to rise, everything else held constant.
1. A) decreases; demand
2. B) increases; demand
3. C) increases; supply
4. D) decreases; supply
Answer: B
40
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for
reserves, lowering the federal funds interest rate, everything else held constant.
1. A) rise; decreases
2. B) rise; increases
3. C) decline; increases
4. D) decline; decreases
Answer: D
41
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a ________ in the reserve requirement decreases the demand for
reserves, ________ the federal funds interest rate, everything else held constant.
1. A) rise; lowering
2. B) decline; raising
3. C) decline; lowering
4. D) rise; raising
Answer: C
42
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a decline in the reserve requirement ________ the ________ curve of
reserves and causes the federal funds interest rate to fall, everything else held constant.
1. A) decreases; demand
2. B) increases; demand
3. C) increases; supply
4. D) decreases; supply
Answer: A
43
In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, a decline in the reserve requirement ________ the demand of
reserves, ________ the federal funds rate, everything else held constant.
1. A) decreases; lowering
2. B) increases; lowering
3. C) increases; raising
4. D) decreases; raising
Answer: A
44
Suppose, at a given federal funds rate, there is an excess demand for reserves in the federal
funds market. If the Fed wants the federal funds rate to stay at that level, then it should
undertake an open market ________ of bonds, everything else held constant. If the Fed does
nothing, however, the federal funds rate will ________.
1. A) sale; increase
2. B) purchase; increase
3. C) sale; decrease
4. D) purchase; decrease
Answer: B
45
Suppose, at a given federal funds rate, there is an excess supply of reserves in the federal funds
market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an
open market ________ of bonds, everything else held constant. If the Fed does nothing, however,
the federal funds rate will ________.
1. A) sale; increase
2. B) purchase; increase
3. C) sale; decrease
4. D) purchase; decrease
Answer: C
46
Explain the Fed's three tools of monetary policy and how each is used to change the money
supply. Does each tool affect the monetary base or the money multiplier?
Answer: The three tools are open market operations, the purchase and sale of government
securities; discount policy, controlling the price and quantity of discount loans to banks; and
reserve requirements, setting the percentage of deposits that banks must hold in reserve. Open
market operations and the discount rate affect the monetary base, and reserve requirements
affect the money multiplier.
47
State whether the following statement is true or false AND explain why: "A decrease in the
discount rate will always cause a decrease in the federal reserve funds rate."
Answer: False. Since the discount rate is set above the federal funds rate, a decrease in the
discount rate will only cause a decrease in the federal funds rate if the discount rate is decreased
below the original federal funds rate level. If the decrease in the discount rate is such that the
new rate is still above the federal funds rate, then the federal funds rate does not change,
everything else held constant.
48
State whether the following statement is true or false AND explain why: "An increase in the
interest rate paid on excess reserves will always cause an increase in the federal reserve funds
rate."
Answer: False. If the interest rate paid on excess reserves is set below the federal funds rate, an
increase in the interest rate paid on excess reserves will only cause an increase in the federal
funds rate if the interest rate paid on excess reserves is increased above the original federal
funds rate level. If the increase in the interest rate paid on excess reserves is such that the new
rate is still below the federal funds rate, then the federal funds rate does not change, everything
else held constant.
49
________ are the most important monetary policy tool because they are the primary determinant
of changes in the ________, the main source of fluctuations in the money supply.
1. A) Open market operations; monetary base
2. B) Open market operations; money multiplier
3. C) Changes in reserve requirements; monetary base
4. D) Changes in reserve requirements; money multiplier
Answer: A
50
Open market purchases raise the ________ thereby raising the ________.
1. A) money multiplier; money supply
2. B) money multiplier; monetary base
3. C) monetary base; money supply
4. D) monetary base; money multiplier
Answer: C
51
Open market purchases ________ reserves and the monetary base thereby ________ the money
supply.
1. A) raise; lowering
2. B) raise; raising
3. C) lower; lowering
4. D) lower; raising
Answer: B
52
Open market sales shrink ________ thereby lowering ________.
1. A) the money multiplier; the money supply
2. B) the money multiplier; reserves and the monetary base
3. C) reserves and the monetary base; the money supply
4. D) the money base; the money multiplier
Answer: C
53
Open market sales ________ reserves and the monetary base thereby ________ the money supply.
1. A) raise; lowering
2. B) raise; raising
3. C) lower; lowering
4. D) lower; raising
Answer: C
54
The two types of open market operations are
1. A) offensive and defensive.
2. B) dynamic and reactionary.
3. C) active and passive.
4. D) dynamic and defensive.
Answer: D
Answer: D
55
There are two types of open market operations: ________ open market operations are intended to
change the level of reserves and the monetary base, and ________ open market operations are
intended to offset movements in other factors that affect the monetary base.
1. A) defensive; dynamic
2. B) defensive; static
3. C) dynamic; defensive
4. D) dynamic; static
Answer: C
56
Open market operations intended to offset movements in noncontrollable factors (such as float)
that affect reserves and the monetary base are called
1. A) defensive open market operations.
2. B) dynamic open market operations.
3. C) offensive open market operations.
4. D) reactionary open market operations.
Answer: A
57
When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of Treasury
funds from the Federal Reserve, the open market operation is said to be
1. A) defensive.
2. B) offensive.
3. C) dynamic.
4. D) reactionary.
Answer: A
58
The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of
government securities, but these purchases or sales are executed by the Federal Reserve Bank of
1. A) Chicago.
2. B) Boston.
3. C) New York.
4. D) San Francisco.
Answer: C
59
The actual execution of open market operations is done at
1. A) the Board of Governors in Washington, D.C.
2. B) the Federal Reserve Bank of New York.
3. C) the Federal Reserve Bank of Philadelphia.
4. D) the Federal Reserve Bank of Boston.
Answer: B
60
If float is predicted to decrease because of unseasonably good weather, the manager of the
trading desk at the Federal Reserve Bank of New York will likely conduct a ________ open market
________ of securities.
1. A) defensive; sale
2. B) defensive; purchase
3. C) dynamic; sale
4. D) dynamic; purchase
Answer: B
61
When bad storms slow the check-clearing process, float tends to ________ causing the Fed to
initiate defensive open market ________.
1. A) decrease; sales
2. B) decrease; purchases
3. C) increase; sales
4. D) increase; purchases
Answer: C
62
When good weather speeds the check-clearing process, float tends to ________ causing the Fed
to initiate defensive open market ________.
1. A) decrease; sales
2. B) decrease; purchases
3. C) increase; sales
4. D) increase; purchases
Answer: B
63
When bad storms slow the check-clearing process, float tends to ________ causing the Fed to
initiate ________ open market ________.
1. A) decrease; defensive; sales
2. B) decrease; dynamic; purchases
3. C) increase; defensive; sales
4. D) increase; dynamic; purchases
Answer: C
64
When good weather speeds the check-clearing process, float tends to ________ causing the Fed
to initiate ________ open market ________.
1. A) decrease; defensive; sales
2. B) decrease; dynamic; sales
3. C) decrease; defensive; purchases
4. D) increase; dynamic; purchases
Answer: C
65
If float is predicted to increase because of bad weather, the manager of the trading desk at the
New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) defensive; inject
2. B) defensive; drain
3. C) dynamic; inject
4. D) dynamic; drain
Answer: B
66
If float is predicted to decrease because of good weather, the manager of the trading desk at
the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) defensive; inject
2. B) defensive; drain
3. C) dynamic; inject
4. D) dynamic; drain
Answer: A
67
If Treasury deposits at the Fed are predicted to increase, the manager of the trading desk at the
New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) defensive; inject
2. B) defensive; drain
3. C) dynamic; inject
4. D) dynamic; drain
Answer: A
68
If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the
New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) increase; defensive; inject
2. B) decrease; defensive; inject
3. C) increase; dynamic; inject
4. D) decrease; dynamic; drain
Answer: A
69
If Treasury deposits at the Fed are predicted to fall, the manager of the trading desk at the New
York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) defensive; inject
2. B) defensive; drain
3. C) dynamic; inject
4. D) dynamic; drain
Answer: B
70
If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the
New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1. A) rise; defensive; drain
2. B) fall; defensive; drain
3. C) rise; dynamic; inject
4. D) fall; dynamic; drain
Answer: B
71
If the Fed expects currency holdings to rise, it conducts open market ________ to offset the
expected ________ in reserves.
1. A) purchases; increase
2. B) purchases; decrease
3. C) sales; increase
4. D) sales; decrease
Answer: B
72
If the Fed expects currency holdings to fall, it conducts open market ________ to offset the
expected ________ in reserves.
1. A) purchases; increase
2. B) purchases; decrease
3. C) sales; increase
4. D) sales; decrease
Answer: C
73
If the banking system has a large amount of reserves, many banks will have excess reserves to
lend and the federal funds rate will probably ________; if the level of reserves is low, few banks
will have excess reserves to lend and the federal funds rate will probably ________.
1. A) fall; fall
2. B) fall; rise
3. C) rise; fall
4. D) rise; rise
Answer: B
74
The Federal Reserve will engage in a repurchase agreement when it wants to ________ reserves
________ in the banking system.
1. A) increase; permanently
2. B) increase; temporarily
3. C) decrease; temporarily
4. D) decrease; permanently
Answer: B
75
If the Fed wants to temporarily inject reserves into the banking system, it will engage in
1. A) a repurchase agreement.
2. B) a matched sale-purchase transaction.
3. C) a reverse repurchase agreement.
4. D) an open market sale.
Answer: A
76
The Fed can offset the effects of an increase in float by engaging in
1. A) a repurchase agreement.
2. B) a matched sale-purchase transaction.
3. C) an interest rate swap.
4. D) an open market purchase.
Answer: B
77
The Federal Reserve will engage in a matched sale-purchase transaction when it wants to
________ reserves ________ in the banking system.
1. A) increase; permanently
2. B) increase; temporarily
3. C) decrease; temporarily
4. D) decrease; permanently
Answer: C
78
Suppose on any given day there is an excess demand of reserves in the federal funds market. If
the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________, everything
else held constant.
1. A) defensive; sale
2. B) defensive; purchase
3. C) dynamic; sale
4. D) dynamic; purchase
Answer: B
79
Suppose on any given day the prevailing equilibrium federal funds rate is above the Federal
Reserve's federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be
at their target level, then the appropriate action for the Federal Reserve to take is a ________
open market ________, everything else held constant.
1. A) defensive; sale
2. B) defensive; purchase
3. C) dynamic; sale
4. D) dynamic; purchase
Answer: D
80
Suppose on any given day there is an excess supply of reserves in the federal funds market. If
the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________, everything
else held constant.
1. A) defensive; sale
2. B) defensive; purchase
3. C) dynamic; sale
4. D) dynamic; purchase
Answer: A
81
Suppose on any given day the prevailing equilibrium federal funds rate is below the Federal
Reserve's federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be
at their target level, then the appropriate action for the Federal Reserve to take is a ________
open market ________, everything else held constant.
1. A) defensive; sale
2. B) defensive; purchase
3. C) dynamic; sale
4. D) dynamic; purchase
Answer: C
82
Discount policy affects the money supply by affecting the volume of ________ and the ________.
1. A) excess reserves; monetary base
2. B) borrowed reserves; monetary base
3. C) excess reserves; money multiplier
4. D) borrowed reserves; money multiplier
Answer: B
83
The discount rate is
1. A) the interest rate the Fed charges on loans to banks.
2. B) the price the Fed pays for government securities.
3. C) the interest rate that banks charge their most preferred customers.
4. D) the price banks pay the Fed for government securities.
Answer: A
84
The most common type of discount lending that the Fed extends to banks is called
1. A) seasonal credit.
2. B) secondary credit.
3. C) primary credit.
4. D) installment credit.
Answer: C
85
The most common type of discount lending, ________ credit loans, are intended to help healthy
banks with short-term liquidity problems that often result from temporary deposit outflows.
1. A) secondary
2. B) primary
3. C) temporary
4. D) seasonal
Answer: B
86
The Fed's discount lending is of three types: ________ is the most common category; ________ is
given to a limited number of banks in vacation and agricultural areas; ________ is given to banks
that have experienced severe liquidity problems.
1. A) seasonal credit; secondary credit; primary credit
2. B) secondary credit; seasonal credit; primary credit
3. C) primary credit; seasonal credit; secondary credit
4. D) seasonal credit; primary credit; secondary credit
Answer: C
87
The discount rate is kept ________ the federal funds rate because the Fed prefers that ________.
1. A) below; banks borrow reserves from each other
2. B) below; banks borrow reserves from the Fed
3. C) above; banks borrow reserves from each other
4. D) above; banks borrow reserves from the Fed
Answer: C
88
The discount rate is kept ________ the federal funds rate because the Fed prefers that ________.
1. A) below; banks can monitor each other for credit risk
2. B) below; the Fed can monitor banks for credit risk
3. C) above; banks can monitor each other for credit risk
4. D) above; the Fed can monitor banks for credit risk
Answer: C
89
The Fed prefers that ________ so that ________.
1. A) banks borrow reserves from each other; banks can monitor each other for credit
risk
2. B) banks borrow reserves from each other; the Fed can monitor banks for credit risk
3. C) banks borrow reserves from the Fed; banks can monitor each other for credit risk
4. D) banks borrow reserves from the Fed; the Fed can monitor banks for credit risk
Answer: A
90
The discount rate refers to the interest rate on
1. A) primary credit.
2. B) secondary credit.
3. C) seasonal credit.
4. D) federal funds.
Answer: A
91
The interest rate on secondary credit is set ________ basis points ________ the primary credit rate.
1. A) 100; above
2. B) 100; below
3. C) 50; above
4. D) 50; below
Answer: C
92
The interest rate on seasonal credit equals
1. A) the federal funds rate.
2. B) the primary credit rate.
3. C) the secondary credit rate.
4. D) an average of the federal funds rate and rates on certificates of deposits.
Answer: D
93
The Fed is considering eliminating
1. A) primary credit lending.
2. B) secondary credit lending.
3. C) seasonal credit lending.
4. D) its lender of last resort function.
Answer: C
94
At its inception, the Federal Reserve was intended to be
1. A) the Treasury's banker.
2. B) the issuer of government debt.
3. C) a lender-of-last-resort.
4. D) a regulator of bank holding companies.
Answer: C
95
Much of the credit for prevention of a financial market meltdown after "Black Monday" (October
19, 1987) must be given to the Federal Reserve System and then-chairman
1. A) Paul Volcker.
2. B) Alan Blinder.
3. C) Arthur Burns.
4. D) Alan Greenspan.
Answer: D
96
A financial panic was averted in October 1987 following "Black Monday" when the Fed
announced that
1. A) it was lowering the discount rate.
2. B) it would provide discount loans to any bank that would make loans to the
security industry.
3. C) it stood ready to purchase common stocks to prevent a further slide in stock
prices.
4. D) it was raising the discount rate.
Answer: B
97
The Fed's lender-of-last-resort function
1. A) has proven to be ineffective.
2. B) cannot prevent runs by large depositors.
3. C) is no longer necessary due to FDIC insurance.
4. D) creates a moral hazard problem.
Answer: D
98
The most important advantage of discount policy is that the Fed can use it to
1. A) precisely control the monetary base.
2. B) perform its role as lender of last resort.
3. C) control the money supply.
4. D) punish banks that have deficient reserves.
Answer: B
99
An increase in ________ reduces the money supply since it causes the ________ to fall.
1. A) reserve requirements; monetary base
2. B) reserve requirements; money multiplier
3. C) margin requirements; monetary base
4. D) margin requirements; money multiplier
Answer: B
100
A decrease in ________ increases the money supply since it causes the ________ to rise.
1. A) reserve requirements; monetary base
2. B) reserve requirements; money multiplier
3. C) margin requirements; monetary base
4. D) margin requirements; money multiplier
Answer: B
101
The Federal Reserve has had the authority to vary reserve requirements since the
1. A) 1920s.
2. B) 1930s.
3. C) 1940s.
4. D) 1950s.
Answer: B
102
Since 1980, ________ are subject to reserve requirements.
1. A) only commercial banks
2. B) only the member institutions of the Federal Reserve
3. C) only nationally chartered depository institutions
4. D) all depository institutions
Answer: D
103
Funds held in ________ are subject to reserve requirements.
1. A) all checkable deposits
2. B) all checkable and time deposits
3. C) all checkable, time, and money market fund deposits
4. D) all time deposits
Answer: A
104
The policy tool of changing reserve requirements is
1. A) the most widely used.
2. B) the preferred tool from the bank's perspective.
3. C) no longer used.
4. D) still used, even with its disadvantages.
Answer: C
105
When the Fed wants to raise interest rates after banks have accumulated large amounts of
excess reserves, it would
1. A) increase the interest rate paid on excess reserves.
2. B) increase discount rate.
3. C) increase the required reserve ratio.
4. D) conduct massive open market purchase.
Answer: A
106
Explain dynamic and defensive open market operations. What is the purpose of each type?
Describe two situations when defensive open market operations are used. How are defensive
open market operations typically conducted?
Answer: Dynamic OMOs are used to permanently change the monetary base and money supply.
Defensive operations are used to offset temporary changes in the monetary base and/or money
supply. Defensive operations are used to offset float, shifts in Treasury balances into or out of
the Fed, and temporary changes in currency. Defensive purchases are typically conducted by
using repurchase agreements, while reverse repos or matched sale-purchase transactions are
used to conduct defensive open market sales.
107
From before the financial crisis began in September of 2007 to when the crisis was over at the
end of 2009, amount of Federal Reserve assets rose, leading to
1. A) a huge increase in the monetary base.
2. B) a huge expansion of the money supply.
3. C) an economic expansion.
4. D) a high inflation.
Answer: A
108
From before the financial crisis began in September of 2007 to when the crisis was over at the
end of 2009, the huge expansion in the Fed's balance sheet and the monetary base did not
result in a large increase in monetary supply because
1. A) most of it just flowed into holdings of excess reserve.
2. B) the Fed also increased the required reserve ratio.
3. C) the Fed also conducted open market sales.
4. D) the discount loan decreased.
Answer: A
109
Which of the following monetary policy tools is more effective when the economy faces the
interest rate zero-lower-bound problem?
1. A) open market operation
2. B) discount policy
3. C) required reserve ratio
4. D) the Fed's liquidity provision
Answer: D
110
The purpose of the commitment by the Fed to keep the federal funds rate at zero for a long
period of time is to
1. A) lower the long term interest rates.
2. B) lower the short term interest rates.
3. C) increase the long term interest rates.
4. D) increase the short term interest rates.
Answer: A
111
The interest rate for primary credit is usually set ________ basis points ________ the federal funds
rate. In March 2008, this gap was changed to ________ basis points.
1. A) 50; below; 100
2. B) 100; above; 25
3. C) 100; below; 50
4. D) 50; above; 25
Answer: B
112
The facility that was created in December of 2007 that banks can use to borrow from the Fed
that has less of a stigma for banks compared to borrowing from the discount window is the
1. A) Term Securities Lending Facility.
2. B) Term Auction Facility.
3. C) Primary Dealer Credit Facility.
4. D) Commercial Paper Funding Facility.
Answer: B
113
The Fed's open market operations normally involve only the purchase of government securities,
particularly those that are short-term. However, during the crisis, the Fed started new programs
to purchase
1. A) mortgage-backed securities and long-term Treasuries.
2. B) mortgage-backed securities and Treasury bills.
3. C) commercial papers and short-term Treasuries.
4. D) Treasury bills and Treasury notes.
Answer: A
114
To lower interest rates on residential mortgages to stimulate the housing market, the Fed
extended its open market operations to purchase
1. A) mortgage-backed securities.
2. B) commercial papers.
3. C) long-term Treasuries.
4. D) Treasury bills and Treasury notes.
Answer: A
115
To lower long-term interest rates, in 2010 the Fed started its new open market operation
program to purchase
1. A) mortgage-backed securities.
2. B) commercial papers.
3. C) long-term Treasuries.
4. D) Treasury bills and Treasury notes.
Answer: C
116
Which of the following statements is an example of the Fed's conditional commitment policy?
1. A) "In these circumstances, the Committee believes that policy accommodation can
be maintained for a considerable period."
2. B) "The Committee anticipates that weak economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for some time."
3. C) "Policy accommodation can be removed at a pace that is likely to be measured."
4. D) "The exceptionally low range for the federal funds rate will be appropriate at
least as long as the
unemployment rate remains above 6-1/2 percent, and inflation between one and two years
ahead is projected to be no more than a half percentage point above the Committee's 2 percent
longer-run goal."
Answer: D
117
Monetary Policy Tools of the European Central Bank
1) The European System of Central Banks signals the stance of its monetary policy by setting a
target for the
1. A) federal funds rate.
2. B) overnight cash rate.
3. C) lombard rate.
4. D) reserve rate.
Answer: B
118
When the European System of Central Banks uses main refinancing operations, it is similar to the
Federal Reserve using
1. A) dynamic open market operations.
2. B) defensive open market operations.
3. C) discount policy.
4. D) reserve requirements.
Answer: B
119
When the European System of Central Banks uses long-term refinancing operations, it is similar
to the Federal Reserve using
1. A) dynamic open market operations.
2. B) defensive open market operations.
3. C) discount policy.
4. D) reserve requirements.
Answer: A
120
The equivalent to the Federal Reserve's discount rate in the European System of Central Banks is
the
1. A) federal funds rate.
2. B) marginal lending rate.
3. C) deposit facility rate.
4. D) lombard rate.
Answer: B
121
The Federal Reserve ________ pay interest on reserves held on deposit. The European System of
Central Banks ________ pay interest on reserves held on deposit.
1. A) does; does
2. B) does; does not
3. C) does not; does
4. D) does not; does not
15.1 Three Players in the Money Supply Process
1) The government agency that oversees the banking system and is responsible for the conduct of
monetary policy in the United States is
A) the Federal Reserve System.
B) the United States Treasury.
C) the U.S. Gold Commission.
D) the House of Representatives.
Answer: A
Ques Status: Previous Edition
AACSB: Reflective Thinking
2) Individuals that lend funds to a bank by opening a checking account are called
A) policyholders.
B) partners.
C) depositors.
D) debt holders.
Answer: C
Ques Status: Previous Edition
AACSB: Reflective Thinking
3) The three players in the money supply process include
A) banks, depositors, and the U.S. Treasury.
B) banks, depositors, and borrowers.
C) banks, depositors, and the central bank.
D) banks, borrowers, and the central bank.
Answer: C
Ques Status: Previous Edition
AACSB: Reflective Thinking
4) Of the three players in the money supply process, most observers agree that the most
important player is
A) the United States Treasury.
B) the Federal Reserve System.
C) the FDIC.
D) the Office of Thrift Supervision.
Answer: B
Ques Status: Previous Edition
AACSB: Reflective Thinking
1
4) Both ________ and ________ are Federal Reserve assets.
A) currency in circulation; reserves
B) currency in circulation; securities
C) securities; loans to financial institutions
D) securities; reserves
Answer: C
5) The monetary liabilities of the Federal Reserve include
A) securities and loans to financial institutions.
B) currency in circulation and reserves.
C) securities and reserves.
D) currency in circulation and loans to financial institutions.
Answer: B
6) Both ________ and ________ are monetary liabilities of the Fed.
A) securities; loans to financial institutions
B) currency in circulation; reserves
C) securities; reserves
D) currency in circulation; loans to financial institutions
Answer: B
7) The sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities is called
A) the money supply.
B) currency in circulation.
C) bank reserves.
D) the monetary base.
Answer: D
8) The monetary base consists of
A) currency in circulation and Federal Reserve notes.
B) currency in circulation and the U.S. Treasury's monetary liabilities.
C) currency in circulation and reserves.
D) reserves and Federal Reserve Notes.
Answer: C
9) Total reserves minus bank deposits with the Fed equals
A) vault cash.
B) excess reserves.
C) required reserves.
D) currency in circulation.
Answer: A
10) Total reserves are the sum of ________ and ________.
A) excess reserves; borrowed reserves
B) required reserves; currency in circulation
C) vault cash; excess reserves
D) excess reserves; required reserves
Answer: D
11) The amount of deposits that banks must hold in reserve is
A) excess reserves.
B) required reserves.
C) total reserves.
D) vault cash.
Answer: B
12) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in
required reserves. Given this information, we can say First National Bank has ________ million
dollars in excess reserves.
A) three
B) nine
C) ten
D) eleven
Answer: B
13) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in
required reserves. Given this information, we can say First National Bank faces a required
reserve ratio of ________ percent.
A) ten
B) twenty
C) eighty
D) ninety
Answer: A
14) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, eight million dollars on deposit with the Federal Reserve, and nine million dollars in
excess reserves. Given this information, we can say First National Bank faces a required reserve
ratio of ________ percent.
A) ten
B) twenty
C) eighty
D) ninety
Answer: A
15) Suppose that from a new checkable deposit, First National Bank holds eight million dollars
on deposit with the Federal Reserve, one million dollars in required reserves, and faces a
required reserve ratio of ten percent. Given this information, we can say First National Bank has
________ million dollars in excess reserves.
A) two
B) eight
C) nine
D) ten
Answer: C
16) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, nine million dollars in excess reserves, and faces a required reserve ratio of ten
percent. Given this information, we can say First National Bank has ________ million dollars in
required reserves.
A) one
B) two
C) eight
D) ten
Answer: A
17) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, nine million dollars in excess reserves, and faces a required reserve ratio of ten
percent. Given this information, we can say First National Bank has ________ million dollars
on deposit with the Federal Reserve.
A) one
B) two
C) eight
D) ten
Answer: C
18) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, one million dollars in required reserves, and faces a required reserve ratio of ten
percent. Given this information, we can say First National Bank has ________ million dollars in
excess reserves.
A) one
B) two
C) nine
D) ten
Answer: C
19) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, one million dollars in required reserves, and faces a required reserve ratio of ten
percent. Given this information, we can say First National Bank has ________ million dollars
on deposit with the Federal Reserve.
A) one
B) two
C) eight
D) ten
Answer: C
20) Suppose that from a new checkable deposit, First National Bank holds eight million dollars
on deposit with the Federal Reserve, nine million dollars in excess reserves, and faces a required
reserve ratio of ten percent. Given this information, we can say First National Bank has
________ million dollars in required reserves.
A) one
B) two
C) nine
D) ten
Answer: A
21) Suppose that from a new checkable deposit, First National Bank holds eight million dollars
on deposit with the Federal Reserve, nine million dollars in excess reserves, and faces a required
reserve ratio of ten percent. Given this information, we can say First National Bank has
________ million dollars in vault cash.
A) one
B) two
C) nine
D) ten
Answer: B
22) The interest rate the Fed charges banks borrowing from the Fed is the
A) federal funds rate.
B) Treasury bill rate.
C) discount rate.
D) prime rate.
Answer: C
23) When banks borrow money from the Federal Reserve, these funds are called
A) federal funds.
B) discount loans.
C) federal loans.
D) Treasury funds.
Answer: B
24) The monetary base minus currency in circulation equals
A) reserves.
B) the borrowed base.
C) the nonborrowed base.
D) discount loans.
Answer: A
25) The monetary base minus reserves equals
A) currency in circulation.
B) the borrowed base.
C) the nonborrowed base.
D) discount loans.
Answer: A
26) High-powered money minus reserves equals
A) reserves.
B) currency in circulation.
C) the monetary base.
D) the nonborrowed base.
Answer: B
27) Purchases and sales of government securities by the Federal Reserve are called
A) discount loans.
B) federal fund transfers.
C) open market operations.
D) swap transactions.
Answer: C
28) When the Federal Reserve purchases a government bond from a bank, reserves in the
banking system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: A
29) When the Federal Reserve sells a government bond to a bank, reserves in the banking system
________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: D
30) When the Fed sells $100 worth of bonds to First National Bank, reserves in the banking
system
A) increase by $100.
B) increase by more than $100.
C) decrease by $100.
D) decrease by more than $100.
Answer: C
31) If a person selling bonds to the Fed cashes the Fed's check, then reserves ________ and
currency in circulation ________, everything else held constant.
A) remain unchanged; declines
B) remain unchanged; increases
C) decline; remains unchanged
D) increase; remains unchanged
Answer: B
32) The effect of an open market purchase on reserves differs depending on how the seller of the
bonds keeps the proceeds. If the proceeds are kept in ________, the open market purchase has no
effect on reserves; if the proceeds are kept as ________, reserves increase by the amount of the
open market purchase.
A) deposits; deposits
B) deposits; currency
C) currency; deposits
D) currency; currency
Answer: C
33) The effect of an open market purchase on reserves differs depending on how the seller of the
bonds keeps the proceeds. If the proceeds are kept in currency, the open market purchase
________ reserves; if the proceeds are kept as deposits, the open market purchase ________
reserves.
A) has no effect on; has no effect on
B) has no effect on; increases
C) increases; has no effect on
D) decreases; increases
Answer: B
34) When an individual sells a $100 bond to the Fed, she may either deposit the check she
receives or cash it for currency. In both cases
A) reserves increase.
B) high-powered money increases.
C) reserves decrease.
D) high-powered money decreases.
Answer: B
35) For which of the following is the change in reserves necessarily different from the change in
the monetary base?
A) Open market purchases from a bank
B) Open market purchases from an individual who deposits the check in a bank
C) Open market purchases from an individual who cashes the check
D) Open market sale to a bank
Answer: C
36) When a member of the nonbank public deposits currency into her bank account,
A) both the monetary base and bank reserves fall.
B) both the monetary base and bank reserves rise.
C) the monetary base falls, but bank reserves remain unchanged.
D) bank reserves rise, but the monetary base remains unchanged.
Answer: D
37) When the Federal Reserve calls in a discount loan from a bank, the monetary base ________
and reserves ________.
A) remains unchanged; decrease
B) remains unchanged; increase
C) decreases; decrease
D) decreases; remains unchanged
Answer: C
38) There are two ways in which the Fed can provide additional reserves to the banking system:
it can ________ government bonds or it can ________ discount loans to commercial banks.
A) sell; extend
B) sell; call in
C) purchase; extend
D) purchase; call in
Answer: C
39) A decrease in ________ leads to an equal ________ in the monetary base in the short run.
A) float; increase
B) float; decrease
C) Treasury deposits at the Fed; decrease
D) discount loans; increase
Answer: B
40) The monetary base declines when
A) the Fed extends discount loans.
B) Treasury deposits at the Fed decrease.
C) float increases.
D) the Fed sells securities.
Answer: D
41) An increase in ________ leads to an equal ________ in the monetary base in the short run.
A) float; decrease
B) float; increase
C) discount loans; decrease
D) Treasury deposits at the Fed; increase
Answer: B
42) Suppose a person cashes his payroll check and holds all the funds in the form of currency.
Everything else held constant, total reserves in the banking system ________ and the monetary
base ________.
A) remain unchanged; increases
B) decrease; increases
C) decrease; remains unchanged
D) decrease; decreases
Answer: C
43) Suppose your payroll check is directly deposited to your checking account. Everything else
held constant, total reserves in the banking system ________ and the monetary base ________.
A) remain unchanged; remains unchanged
B) remain unchanged; increases
C) decrease; increases
D) decrease; decreases
Answer: A
44) The Fed does not tightly control the monetary base because it does not completely control
A) open market purchases.
B) open market sales.
C) borrowed reserves.
D) the discount rate.
Answer: C
45) Subtracting borrowed reserves from the monetary base obtains
A) reserves.
B) high-powered money.
C) the nonborrowed monetary base.
D) the borrowed monetary base.
Answer: C
46) The relationship between borrowed reserves, the nonborrowed monetary base, and the
monetary base is
A) MB = MBn - BR.
B) BR = MBn - MB.
C) BR = MB - MBn.
D) MB = BR - MBn.
Answer: C
47) When the Fed supplies the banking system with an extra dollar of reserves, deposits
________ by ________ than one dollar—a process called multiple deposit creation.
A) increase; less
B) increase; more
C) decrease; less
D) decrease; more
Answer: B
48) If the required reserve ratio is equal to 10 percent, a single bank can increase its loans up to a
maximum amount equal to
A) its excess reserves.
B) 10 times its excess reserves.
C) 10 percent of its excess reserves.
D) its total reserves.
Answer: A
49) In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a
bank that previously had no excess reserves, the bank can now increase its loans by
A) $10.
B) $100.
C) $100 times the reciprocal of the required reserve ratio.
D) $100 times the required reserve ratio.
Answer: B
50) The formula for the simple deposit multiplier can be expressed as
A) △R = × △T
B) △D = × △R
C) △rr = × △T
D) △R = × △D
Answer: B
51) In the simple model of multiple deposit creation in which banks do not hold excess reserves,
the increase in checkable deposits equals the product of the change in reserves and the
A) reciprocal of the excess reserve ratio.
B) simple deposit expansion multiplier.
C) reciprocal of the simple deposit multiplier.
D) discount rate.
Answer: B
52) If reserves in the banking system increase by $100, then checkable deposits will increase by
$1000 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.10.
C) 0.05.
D) 0.20.
Answer: B
53) If the required reserve ratio is 10 percent, the simple deposit multiplier is
A) 5.0.
B) 2.5.
C) 100.0.
D) 10.0
Answer: D
54) If the required reserve ratio is 15 percent, the simple deposit multiplier is
A) 15.0.
B) 1.5.
C) 6.67.
D) 3.33.
Answer: C
55) In the simple deposit expansion model, if the banking system has excess reserves of $75, and
the required reserve ratio is 20%, the potential expansion of checkable deposits is
A) $75.
B) $750.
C) $37.50.
D) $375.
Answer: D
56) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when
the required reserve ratio is equal to 20 percent implies that the Fed
A) sold $200 in government bonds.
B) sold $500 in government bonds.
C) purchased $200 in government bonds.
D) purchased $500 in government bonds.
Answer: C
57) If reserves in the banking system increase by $100, then checkable deposits will increase by
$667 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.05.
C) 0.15.
D) 0.20.
Answer: C
58) If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if the
reserve requirement is 20 percent, then the bank has actual reserves of
A) $16,000.
B) $20,000.
C) $26,000.
D) $36,000.
Answer: C
59) If a bank has excess reserves of $20,000 and demand deposit liabilities of $80,000, and if the
reserve requirement is 20 percent, then the bank has total reserves of
A) $16,000.
B) $20,000.
C) $26,000.
D) $36,000.
Answer: D
60) If a bank has excess reserves of $5,000 and demand deposit liabilities of $80,000, and if the
reserve requirement is 20 percent, then the bank has actual reserves of
A) $11,000.
B) $20,000.
C) $21,000.
D) $26,000.
Answer: C
61) If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the
reserve requirement is 15 percent, then the bank has actual reserves of
A) $17,000.
B) $19,000.
C) $24,000.
D) $29,000.
Answer: B
62) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000, and if the
reserve requirement is 10 percent, then the bank has actual reserves of
A) $14,000.
B) $17,000.
C) $22,000.
D) $27,000.
Answer: B
63) A bank has excess reserves of $10,000 and demand deposit liabilities of $100,000 when the
required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess
reserves will be
A) -$5,000.
B) -$1,000.
C) $1,000.
D) $5,000.
Answer: D
64) Decisions by depositors to increase their holdings of ________, or of banks to hold
________ will result in a smaller expansion of deposits than the simple model predicts.
A) deposits; required reserves
B) deposits; excess reserves
C) currency; required reserves
D) currency; excess reserves
Answer: D
65) Decisions by ________ about their holdings of currency and by ________ about their
holdings of excess reserves affect the money supply.
A) borrowers; depositors
B) banks; depositors
C) depositors; borrowers
D) depositors; banks
Answer: D
66) An increase in the nonborrowed monetary base, everything else held constant, will cause
A) the money supply to fall.
B) the money supply to rise.
C) no change in the money supply.
D) demand deposits to fall.
Answer: B
67) The amount of borrowed reserves is ________ related to the discount rate, and is ________
related to the market interest rate.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
Answer: B
68) A ________ in market interest rates relative to the discount rate will cause discount
borrowing to ________.
A) fall; increase
B) rise; decrease
C) rise; increase
D) fall; remain unchanged
Answer: C
69) Models describing the determination of the money supply and the Fed's role in this process
normally focus on ________ rather than ________, since Fed actions have a more predictable
effect on the former.
A) reserves; the monetary base
B) reserves; high-powered money
C) the monetary base; high-powered money
D) the monetary base; reserves
Answer: D
70) The Fed can exert more precise control over ________ than it can over ________.
A) high-powered money; reserves
B) high-powered money; the monetary base
C) the monetary base; high-powered money
D) reserves; high-powered money
Answer: A
71) The ratio that relates the change in the money supply to a given change in the monetary base
is called the
A) money multiplier.
B) required reserve ratio.
C) deposit ratio.
D) discount rate.
Answer: A
72) The formula linking the money supply to the monetary base is
A) M = m/MB.
B) M = m × MB.
C) m = M × MB.
D) MB = M × m.
E) M = m + MB.
Answer: B
73) An increase in the monetary base that goes into ________ is not multiplied, while an increase
that goes into ________ is multiplied.
A) deposits; currency
B) excess reserves; currency
C) currency; excess reserves
D) currency; deposits
Answer: D
74) If the Fed injects reserves into the banking system and they are held as excess reserves, then
the money supply
A) increases by only the initial increase in reserves.
B) increases by only one-half the initial increase in reserves.
C) increases by a multiple of the initial increase in reserves.
D) does not change.
Answer: D
75) The formula that links checkable deposits to the monetary base is
77) The formula for the M1 money multiplier is
A) m = (1 + c)/(rr + e + c).
B) M = 1/(rr + e + c).
C) M = (1 + c)/(rr + e + c).
D) m = [1/(rr + e + c)] × MB.
Answer: A
78) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is
________ billion.
A) $8000
B) $1200
C) $1200.8
D) $8400
Answer: B
79) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 1.67.
C) 2.0.
D) 0.601.
Answer: A
80) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is
A) 0.25
B) 0.50.
C) 0.40.
D) 0.05.
Answer: B
81) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the excess reservescheckable deposit ratio is
A) 0.001.
B) 0.10.
C) 0.01.
D) 0.05.
Answer: A
82) If the required reserve ratio is 5 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 2.72.
C) 2.3.
D) 0.551.
Answer: B
83) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is
________ billion.
A) $10,000
B) $4000
C) $1400
D) $10,400
Answer: C
84) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $1000 billion, and excess reserves total $1 billion, then the currency ratio is
A) 0.25.
B) 0.50.
C) 0.40.
D) 0.05.
Answer: C
85) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $1000 billion, and excess reserves total $1 billion, then the excess reservescheckable deposit ratio i
A) 0.01.
B) 0.10.
C) 0.001.
D) 0.05.
Answer: C
86) If the required reserve ratio is one-third, currency in circulation is $300 billion, and
checkable deposits are $900 billion, then the currency ratio is
A) 0.25.
B) 0.33.
C) 0.67.
D) 0.375.
Answer: B
87) If the required reserve ratio is one-third, currency in circulation is $300 billion, checkable
deposits are $900 billion, and there is no excess reserve, then the monetary base is
A) $300 billion.
B) $600 billion.
C) $333 billion.
D) $667 billion.
Answer: B
88) Everything else held constant, an increase in the required reserve ratio on checkable deposits
will cause
A) the money supply to rise.
B) the money supply to remain constant.
C) the money supply to fall.
D) checkable deposits to rise.
Answer: C
89) Everything else held constant, a decrease in the required reserve ratio on checkable deposits
will mean
A) a decrease in the money supply.
B) an increase in the money supply.
C) a decrease in checkable deposits.
D) an increase in discount loans.
Answer: B
90) Everything else held constant, a decrease in the required reserve ratio on checkable deposits
causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
Answer: B
91) Assuming initially that rr = 10%, c = 40%, and e = 0, an increase in rr to 15% causes the M1
money multiplier to ________, everything else held constant.
A) increase from 2.55 to 2.8
B) decrease from 2.8 to 2.55
C) increase from 1.82 to 2
D) decrease from 2 to 1.82
Answer: B
92) Assuming initially that rr = 10%, c = 40%, and e = 0, a decrease in rr to 5% causes the M1
money multiplier to ________, everything else held constant.
A) increase from 2.8 to 3.11
B) decrease from 3.11 to 2.8
C) increase from 2 to 2.22
D) decrease from 2.22 to 2
Answer: A
93) Everything else held constant, an increase in the currency-checkable deposit ratio will mean
A) an increase in currency in circulation and an increase in the money supply.
B) an increase in money supply but no change in reserves.
C) a decrease in the money supply.
D) an increase in currency in circulation but no change in the money supply.
Answer: C
94) Everything else held constant, an increase in the currency ratio causes the M1 money
multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; decrease
C) decrease; decrease
D) increase; increase
Answer: C
95) Everything else held constant, a decrease in the currency ratio causes the M1 money
multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
Answer: B
96) Everything else held constant, a decrease in the excess reserves ratio causes the M1 money
multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
Answer: B
97) The excess reserves ratio is ________ related to expected deposit outflows, and is ________
related to the market interest rate.
A) negatively; negativel
B) negatively; positively
C) positively; negatively
D) positively; positively
Answer: C
98) The money supply is ________ related to expected deposit outflows, and is ________ related
to the market interest rate.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
Answer: B
99) The money multiplier is
A) negatively related to high-powered money.
B) positively related to the excess reserves ratio.
C) negatively related to the required reserve ratio.
D) positively related to holdings of excess reserves.
Answer: C
100) During the 2007-2009 financial crisis the currency ratio
A) increased sharply.
B) decreased sharply.
C) increased slightly.
D) decreased slightly.
Answer: D
101) During the 2007-2009 financial crisis the excess reserve ratio
A) increased sharply.
B) decreased sharply.
C) increased slightly.
D) decreased slightly.
Answer: A
Chapter 16
1
The most common definition that monetary policymakers use for price stability is
1. A) low and stable deflation.
2. B) an inflation rate of zero percent.
3. C) high and stable inflation.
4. D) low and stable inflation.
Answer: D
2
Inflation results in
1. A) ease of planning for the future.
2. B) ease of comparing prices over time.
3. C) lower nominal interest rates.
4. D) difficulty interpreting relative price movements.
Answer: D
3
Economists believe that countries recently suffering hyperinflation have experienced
1. A) reduced growth.
2. B) increased growth.
3. C) reduced prices.
4. D) lower interest rates.
Answer: A
4
A nominal variable, such as the inflation rate or the money supply, which ties down the price
level to achieve price stability is called ________ anchor.
1. A) a nominal
2. B) a real
3. C) an operating
4. D) an intermediate
Answer: A
5
A central feature of monetary policy strategies in all countries is the use of a nominal variable
that monetary policymakers use as an intermediate target to achieve an ultimate goal such as
price stability. Such a variable is called a nominal
1. A) anchor.
2. B) benchmark.
3. C) tether.
4. D) guideline.
Answer: A
6
A nominal anchor promotes price stability by
1. A) outlawing inflation.
2. B) stabilizing interest rates.
3. C) keeping inflation expectations low.
4. D) keeping economic growth low.
Answer: C
7
Monetary policy is considered time-inconsistent because
1. A) of the lag times associated with the implementation of monetary policy and its
effect on the economy.
2. B) policymakers are tempted to pursue discretionary policy that is more
contractionary in the short run.
3. C) policymakers are tempted to pursue discretionary policy that is more
expansionary in the short run.
4. D) of the lag times associated with the recognition of a potential economic
problem and the implementation of monetary policy.
Answer: C
8
The time-inconsistency problem with monetary policy tells us that, if policymakers use
discretionary policy, there is a higher probability that the ________ will be higher, compared to
policy makers following a behavior rule.
1. A) inflation rate
2. B) unemployment rate
3. C) interest rate
4. D) foreign exchange rate
Answer: A
9
The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor
long-run outcomes is referred to as the
1. A) adverse selection problem.
2. B) moral hazard problem.
3. C) time-inconsistency problem.
4. D) nominal-anchor problem.
Answer: C
10
The ________ problem of discretionary policy arises because economic behavior is influenced by
what firms and people expect the monetary authorities to do in the future.
1. A) moral hazard
2. B) time-inconsistency
3. C) nominal-anchor
4. D) rational-expectation
Answer: B
11
If the central bank pursues a monetary policy that is more expansionary than what firms and
people expect, then the central bank must be trying to
1. A) boost output in the short run.
2. B) constrain output in the short run.
3. C) constrain prices.
4. D) boost prices in the short run.
12
The time-inconsistency problem in monetary policy can occur when the central bank conducts
policy
1. A) using a nominal anchor.
2. B) using a strict and inflexible rule.
3. C) on a discretionary, day-by-day basis.
4. D) using a flexible, discretionary rule.
Answer: C
13
Explain the time-inconsistency problem. What is the likely outcome of discretionary policy?
What are the solutions to the time-inconsistency problem?
Answer: With policy discretion, policymakers have an incentive to attempt to increase output by
pursuing expansionary policies once expectations are set. The problem is that this policy results
not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule
to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary
behavior.
14
Even if the Fed could completely control the money supply, monetary policy would have critics
because
1. A) the Fed is asked to achieve many goals, some of which are incompatible with
others.
2. B) the Fed's goals do not include high employment, making labor unions a critic of
the Fed.
3. C) the Fed's primary goal is exchange rate stability, causing it to ignore domestic
economic conditions.
4. D) it is required to keep Treasury security prices high.
Answer: A
15
High unemployment is undesirable because it
1. A) results in a loss of output.
2. B) always increases inflation.
3. C) always increases interest rates.
4. D) reduces idle resources.
Answer: A
16
When workers voluntarily leave work while they look for better jobs, the resulting
unemployment is called
1. A) structural unemployment.
2. B) frictional unemployment.
3. C) cyclical unemployment.
4. D) underemployment.
Answer: B
17
Unemployment resulting from a mismatch of workers' skills and job requirements is called
1. A) frictional unemployment.
2. B) structural unemployment.
3. C) seasonal unemployment.
4. D) cyclical unemployment.
Answer: B
18
The goal for high employment should be a level of unemployment at which the demand for
labor equals the supply of labor. Economists call this level of unemployment the
1. A) frictional level of unemployment.
2. B) structural level of unemployment.
3. C) natural rate level of unemployment.
4. D) Keynesian rate level of unemployment.
Answer: C
19
Supply-side economic policies seek to
1. A) raise interest rates through contractionary monetary policy.
2. B) increase federal government expenditures.
3. C) increase consumption expenditures by increasing taxes.
4. D) increase saving and investment using tax incentives.
Answer: D
20
The Federal Reserve System was created to
1. A) make it easier to finance budget deficits.
2. B) promote financial market stability.
3. C) lower the unemployment rate.
4. D) promote rapid economic growth.
Answer: B
21
Having interest rate stability
1. A) allows for less uncertainty about future planning.
2. B) leads to demands to curtail the Fed's power.
3. C) guarantees full employment.
4. D) leads to problems in financial markets.
Answer: A
22
Foreign exchange rate stability is important because a decline in the value of the domestic
currency will ________ the inflation rate, and an increase in the value of the domestic currency
makes domestic industries ________ competitive with competing foreign industries.
1. A) increase; more
2. B) increase; less
3. C) decrease; more
4. D) decrease; less
Answer: B
23
Which set of goals can, at times, conflict in the short run?
1. A) high employment and economic growth
2. B) interest rate stability and financial market stability
3. C) high employment and price level stability
4. D) exchange rate stability and financial market stability
Answer: C
24
The primary goal of the European Central Bank is
1. A) price stability.
2. B) exchange rate stability.
3. C) interest rate stability.
4. D) high employment.
Answer: A
25
The mandate for the monetary policy goals that has been given to the European Central Bank is
an example of a ________ mandate.
1. A) primary
2. B) dual
3. C) secondary
4. D) hierarchical
Answer: D
26
The mandate for the monetary policy goals that has been given to the Federal Reserve System is
an example of a ________ mandate.
1. A) primary
2. B) dual
3. C) secondary
4. D) hierarchical
Answer: B
27
Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the
________.
1. A) price stability; short run
2. B) price stability; long run
3. C) reducing business-cycle fluctuations; short run
4. D) reducing business-cycle fluctuations; long run
Answer: B
28
The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is
1. A) monetary targeting.
2. B) inflation targeting.
3. C) targeting with an implicit nominal anchor.
4. D) interest-rate targeting.
Answer: B
29
Which of the following is not an element of inflation targeting?
1. A) a public announcement of medium-term numerical targets for inflation
2. B) an institutional commitment to price stability as the primary long-run goal
3. C) an information-inclusive approach in which only monetary aggregates are used
in making decisions about monetary policy
4. D) increased accountability of the central bank for attaining its inflation objectives
Answer: C
30
The first country to adopt inflation targeting was
1. A) the United Kingdom.
2. B) Canada.
3. C) New Zealand.
4. D) Australia.
Answer: C
31
In both New Zealand and Canada, what has happened to the unemployment rate since the
countries adopted inflation targeting?
1. A) The unemployment rate increased sharply.
2. B) The unemployment rate remained constant.
3. C) The unemployment rate has declined substantially after a sharp increase.
4. D) The unemployment rate declined sharply immediately after the inflation targets
were adopted.
Answer: C
32
Which of the following is not an advantage of inflation targeting?
1. A) reduction of the time-inconsistency problem
2. B) increased monetary policy transparency
3. C) There is an immediate signal on the achievement of the target.
4. D) consistency with democratic principles
Answer: C
33
Which of the following is not a disadvantage to inflation targeting?
1. A) There is a delayed signal about achievement of the target.
2. B) Inflation targets could impose a rigid rule on policymakers.
3. C) There is potential for larger output fluctuations.
4. D) There is a lack of transparency.
Answer: D
34
The decision by inflation targeters to choose inflation targets ________ zero reflects the concern
of monetary policymakers that particularly ________ inflation can have substantial negative effects
on real economic activity.
1. A) below; high
2. B) below; low
3. C) above; high
4. D) above; low
Answer: D
35
Inflation targets can increase the central bank's flexibility in responding to declines in aggregate
spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of
the target range will automatically stimulate the central bank to ________ monetary policy
without fearing that this action will trigger a rise in inflation expectations.
1. A) demand: tighten
2. B) demand; loosen
3. C) supply; tighten
4. D) supply; loosen
Answer: B
36
Explain what inflation targeting is. What are the advantages and disadvantages of this type of
monetary policy strategy?
Answer: There are five main elements to inflation targeting: 1. a public announcement of a
medium-term target for the inflation rate; 2. a commitment to price stability as the primary
long-term goal of policy; 3. many variables are used in making decisions about policy moves; 4.
increased transparency about policy strategy with the public; 5. the central bank has increased
accountability for attaining policy goals.
The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical target
for the inflation rate; 2. there is increased accountability of the central bank; 3. reduces the
effects of inflationary shocks.
The disadvantages of inflation targeting include: 1. there is a delayed signal about the
achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation rate
(has not happened in practice); 3. if sole focus is the inflation rate, larger output fluctuations can
occur (has not happened in practice).
37
The type of monetary policy regime that the Federal Reserve has followed From the 1980s up
until the time Ben Bernanke became chair of the Federal Reserve in 2006 can best be described
as
1. A) monetary targeting.
2. B) inflation targeting.
3. C) policy with an implicit nominal anchor.
4. D) exchange-rate targeting.
Answer: C
38
Estimates from large macroeconometric models of the U.S. economy suggests that it takes over
________ for monetary policy to affect output and over ________ for monetary policy to affect the
inflation rate.
1. A) 1 year; 2 years
2. B) 2 years; 1 year
3. C) 1 year; 6 months
4. D) 6 months; 1 year
Answer: A
39
Which of the following is not a disadvantage of of the Fed's "just do it" approach to monetary
policy?
1. A) There is low transparency of policy.
2. B) There is low accountability for central bankers.
3. C) This type of policy make the Fed more susceptible to the time-inconsistency
problem.
4. D) It relies on a stable money-inflation relationship.
Answer: D
40
Suppose it takes roughly two years for monetary policy to have a significant impact on inflation.
If inflation is currently low but policymakers believe inflation will rise over the next two years
with an unchanged stance of monetary policy, when should they tighten monetary policy to
prevent the inflationary surge?
1. A) now
2. B) wait until overt signs of inflation appear
3. C) next year
4. D) two years later
Answer: A
41
Under Alan Greenspan and Ben Bernanke, the Federal Reserve was successful in
pursuing a ________ policy.
1. A) preemptive
2. B) inflation targeting
3. C) exchange rate targeting
4. D) monetary targeting
Answer: A
42
After Ben Bernanke became chair of the Fed in 2006, he
1. A) increased Fed transparency.
2. B) abandoned inflation targeting.
3. C) used "just do it" policy.
4. D) increased the opacity of the policymaking.
Answer: A
43
The FOMC finally moved to ________ on January 25, 2012, when it issued its "Statement on LongRun
Goals and Monetary Policy Strategy."
1. A) inflation targeting
2. B) zero inflation policy
3. C) "just do it" policy
4. D) monetary targeting
Answer: A
44
In the FOMC's "Statement on Long-Run Goals and Monetary Policy Strategy,"the FOMC agreed
to a single numerical value of the inflation objective, 2% on the ________.
1. A) PCE deflator
2. B) GDP deflator
3. C) CPI
4. D) PPI
Answer: A
45
The FOMC "Statement on Long-Run Goals and Monetary Policy Strategy"made it clear that the
Federal Reserve would be pursuing ________, consistent with its dual mandate.
1. A) a flexible form of inflation targeting
2. B) a strict form of inflation targeting
3. C) a zero inflation targeting
4. D) an implicit inflation targeting
Answer: A
46
Lessons that economists and policy makers have learned from the recent global financial crisis
include
1. A) Developments in the financial sector have a far greater impact on economic
activity than was earlier realized.
2. B) The zero lower bound on interest rates can be a serious problem.
3. C) The cost of cleaning up after a financial crisis is very high.
4. D) Price and output stability do not ensure financial stability.
5. E) All of the above.
Answer: E
47
The problems of raising the level of the inflation target include
1. A) if the zero-lower-bound problem is rare, then the benefits of a higher inflation
target are not very large.
2. B) the costs of higher inflation in terms of the distortions it produces in the
economy are high.
3. C) it is more difficult to stabilize the inflation rate at a higher targeting level.
4. D) all of the above.
Answer: D
48
The "Greenspan doctrine"—central banks should not try to prick bubbles—was based on which
of the following arguments?
1. A) Asset-price bubbles are nearly impossible to identify.
2. B) Monetary actions would be likely to affect asset prices in general, rather than the
specific assets that are experiencing a bubble.
3. C) Raising interest rates has often been found to cause a bubble to burst more
severely.
4. D) Monetary policy actions to prick bubbles can have harmful effects on the
aggregate economy.
5. E) All of the above.
Answer: E
49
When asset prices increase above their fundamental values it is called an
1. A) asset-price bubble.
2. B) irrational bubble.
3. C) asset-price spike.
4. D) irrational spike.
Answer: A
50
Suppose interest rates are kept very low for a long time such that there is a spike in the amount
of lending. Everything else held constant, this could cause ________ bubble.
1. A) an irrational exuberance
2. B) a credit-driven
3. C) a stock
4. D) a debt-driven
Answer: B
51
A credit-driven bubble arises when ________ in lending causes ________ in asset prices which can
cause ________ in lending.
1. A) a decrease; a decrease; an increase
2. B) a decrease; an increase; an increase
3. C) an increase; an increase; a further increase
4. D) a decrease; a decrease; a further decrease
Answer: C
52
________ bubble is driven entirely by unrealistic optimistic expectations.
1. A) An irrational exuberance
2. B) A credit-driven
3. C) A stock
4. D) A debt-driven
Answer: A
53
Everything else held constant, a credit-drive bubble is generally considered to have the potential
to cause ________ damage to an economy compared to an irrational exuberance bubble.
1. A) less
2. B) about the same amount of
3. C) more
4. D) either more, less, or the same amount of
Answer: C
54
A central bank has ________ chance to identify a credit-driven bubble compared to an irrational
exuberance bubble.
1. A) a greater
2. B) less of a
3. C) about the same level of a
4. D) a greater, less or about the same level of a
Answer: A
55
Which of the following is NOT an argument against using monetary policy to prick asset-price
bubbles?
1. A) The effect of increasing interest rates on asset prices is uncertain.
2. B) A bubble may only exist in some asset-prices and monetary policy will affect all
asset prices.
3. C) Using monetary policy to prick an asset-price bubble may have adverse effect on
the aggregate economy.
4. D) Even though credit-drive bubbles are easier to identify, they are still relatively
hard to identify.
Answer: D
56
Which of the following is NOT an operating instrument?
1. A) nonborrowed reserves
2. B) monetary base
3. C) federal funds interest rate
4. D) discount rate
Answer: D
57
Which of the following is a potential operating instrument for the central bank?
1. A) the monetary base
2. B) the M1 money supply
3. C) nominal GDP
4. D) the discount rate
Answer: A
58
Due to the lack of timely data for the price level and economic growth, the Fed's strategy
1. A) targets the exchange rate, since the Fed can control this variable.
2. B) targets the price of gold, since it is closely related to economic activity.
3. C) uses an intermediate target, such as an interest rate.
4. D) stabilizes the consumer price index, since the Fed can control the CPI.
Answer: C
59
If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate
because
1. A) of fluctuations in the demand for reserves.
2. B) of fluctuations in the consumption function.
3. C) bond values will tend to remain stable.
4. D) of fluctuations in the business cycle.
Answer: A
60
If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand
are prevalent
1. A) fluctuations of nonborrowed reserves will be small.
2. B) fluctuations of nonborrowed reserves will be large.
3. C) the Fed will probably quickly abandon this policy, as it did in the 1960s.
4. D) the Fed will probably quickly abandon this policy, as it did in the 1950s.
Answer: B
61
Fluctuations in the demand for reserves cause the Fed to lose control over a monetary
aggregate if the Fed targets
1. A) a monetary aggregate.
2. B) the monetary base.
3. C) an interest rate.
4. D) nominal GDP.
Answer: C
62
Real interest rates are difficult to measure because
1. A) data on them are not available in a timely manner.
2. B) real interest rates depend on the hard-to-determine expected inflation rate.
3. C) they fluctuate too often to be accurate.
4. D) they cannot be controlled by the Fed.
Answer: B
63
Which of the following criteria need NOT be satisfied for choosing a policy instrument?
1. A) The variable must be measurable.
2. B) The variable must be controllable.
3. C) The variable must be predictable.
4. D) The variable must be transportable.
Answer: D
64
Which of the following is NOT a requirement in selecting a policy instrument?
1. A) measurability
2. B) controllability
3. C) flexibility
4. D) predictability
Answer: C
65
When it comes to choosing an policy instrument, both the ________ rate and ________ aggregates
are measured accurately and are available daily with almost no delay.
1. A) three-month T-bill; monetary
2. B) three-month T-bill; reserve
3. C) federal funds; monetary
4. D) federal funds; reserve
Answer: D
66
Explain and demonstrate graphically how targeting nonborrowed reserves can result in federal
funds rate instability.
Answer: See figure - Chapter 16 Number 66
When nonborrowed reserves are held constant, increases in the demand for reserves result in
the federal funds rate increasing and decreases in the demand for nonborrowed reserves result
in the federal funds rate declining. Since fluctuations in demand do not cause monetary policy
actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds
rate is below the discount rate).
67
Explain and demonstrate graphically how targeting the federal funds rate can result in
fluctuations in nonborrowed reserves.
Answer: See figure - Chapter 16 Number 67
With a federal funds rate target, fluctuations in demand for reserves require similar changes in
the nonborrowed reserves to keep the federal funds rate constant.
68
According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation
________ the Fed's inflation target or when real GDP ________ the Fed's output target.
1. A) rises above; drops below
2. B) drops below; drops below
3. C) rises above; rises above
4. D) drops below; rises above
Answer: C
69
Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output
gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent,
the nominal federal funds rate target should be
1. A) 5 percent.
2. B) 5.5 percent.
3. C) 6 percent.
4. D) 6.5 percent.
Answer: D
70
Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output
gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal
federal funds rate should be
1. A) 0 percent.
2. B) 1 percent.
3. C) 2 percent.
4. D) 3 percent.
Answer: B
71
According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should
be ________ by ________ than the inflation rate increase.
1. A) increased; more
2. B) increased; less
3. C) decreased; more
4. D) decreased; less
Answer: A
72
If the Taylor Principle is not followed and nominal interest rates are increased by less than the
increase in the inflation rate, then real interest rates will ________ and monetary policy will be too
________.
1. A) rise; tight
2. B) rise; loose
3. C) fall; tight
4. D) fall; loose
Answer: D
73
The rate of inflation tends to remain constant when
1. A) the unemployment rate is above the NAIRU.
2. B) the unemployment rate equals the NAIRU.
3. C) the unemployment rate is below the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: B
74
The rate of inflation increases when
1. A) the unemployment rate equals the NAIRU.
2. B) the unemployment rate exceeds the NAIRU.
3. C) the unemployment rate is less than the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: C
75
Explain the Taylor rule, including the formula for setting the federal funds rate target, and the
components of the formula. If the Fed were to use this rule, how many goals would it use to set
monetary policy?
Answer: The Taylor rule specifies that the target federal fund rates should be set to equal the
equilibrium real federal funds rate, plus the rate of inflation (for the Fisher effect), plus one-half
times the output gap, plus one-half times the inflation gap. The formula is
Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output gap) +
(inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment real
GDP. The inflation gap is the difference between actual inflation and the central bank's target
rate of inflation. The equilibrium real federal funds rate is the real rate consistent with full
employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets
the federal funds rate recognizing the goals of low inflation and full employment (or equilibrium
long-run economic growth).
76
In pursuing a strategy of monetary targeting, the central bank announces that it will achieve a
certain value (the target) of the annual growth rate of a ________.
1. A) a monetary aggregate
2. B) a reserve aggregate
3. C) the monetary base
4. D) GDP
Answer: A
77
During the years 1979 to 1982, the Federal Reserve's announced policy was monetary targeting.
During this time period the Federal Reserve
1. A) hit all of their monetary targets.
2. B) did not hit any of their monetary targets because it is believed that controlling
the money supply was not the intent of the Federal Reserve.
3. C) did not hit any of their monetary targets because they were unrealistic.
4. D) hit about half of their monetary targets.
Answer: B
78
Compared to the United States, Japan's experience with monetary targeting during the 1978––
1987 period performed
1. A) better with regard to the inflation rate and output fluctuations.
2. B) worse with regard to the inflation rate and output fluctuations.
3. C) better with regard to the inflation rate, but worse with regard to output
fluctuations.
4. D) worse with regard to the inflation rate, but better with regard to output
fluctuations.
Answer: A
79
One of the factors that contributed to the success German policymakers had using a monetary
targeting type policy starting in the mid-1970s and continuing through the next two decades
was that
1. A) they used a rigid target for the money growth rate.
2. B) they implemented policy so their inflation rate goal was met in the short run.
3. C) the money target was flexible to allow the Bundesbank to concentrate on other
goals as needed.
4. D) they rarely communicated the intentions of policy to the public in order to keep
the public from panicking.
Answer: C
80
The European Central Bank (ECB) pursues a hybrid monetary policy strategy that has elements in
common with the -targeting strategy previously used by the Bundesbank but also includes some
elements of targeting.
1. A) monetary; inflation
2. B) inflation; monetary
3. C) monetary; exchange rate
4. D) monetary; nominal GDP
Answer: A
81
Which of the following is an advantage to money targeting?
1. A) There is an immediate signal on the achievement of the target.
2. B) It does not rely on a stable money-inflation relationship.
3. C) It implies lack of transparency.
4. D) It implies smaller output fluctuations.
Answer: A
82
Which of the following is a disadvantage to monetary targeting?
1. A) It relies on a stable money-inflation relationship.
2. B) There is a delayed signal about the achievement of a target.
3. C) It implies larger output fluctuations.
4. D) It implies a lack of transparency.
Answer: A
83
If the relationship between the monetary aggregate and the goal variable is weak, then
1. A) monetary aggregate targeting is superior to exchange-rate targeting.
2. B) monetary aggregate targeting is superior to inflation targeting.
3. C) inflation targeting is superior to exchange-rate targeting.
4. D) monetary aggregate targeting will not work.
Answer: D
84
The monetary policy strategy that relies on a stable money-income relationship is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: B
85
In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary policy
was known as the
1. A) real bills doctrine.
2. B) liberal liquidity doctrine.
3. C) free reserves doctrine.
4. D) quantity theory of money.
Answer: A
86
The guiding principle for the conduct of monetary policy that held that as long as loans were
being made for "productive" purposes, then providing reserves to the banking system to make
these loans would not be inflationary became known as the
1. A) free reserves doctrine.
2. B) Benjamin Strong doctrine.
3. C) efficient liquidity doctrine.
4. D) real bills doctrine.
Answer: D
87
The real bills doctrine was the guiding principle for the conduct of monetary policy during the
1. A) 1910s.
2. B) 1940s.
3. C) 1950s.
4. D) 1960s.
Answer: A
88
The Fed accidentally discovered open market operations in the early
1. A) 1920s.
2. B) 1910s.
3. C) 1900s.
4. D) 1890s.
Answer: A
89
The Fed accidentally discovered open market operations when
1. A) it came to the rescue of failing banks in the early 1930s, and found that its
purchases of bank loans injected reserves into the banking system.
2. B) it purchased securities for income following the 1920-1921 recession.
3. C) it attempted to slow inflation in 1919 by selling securities and found that its sales
drained reserves from the banking system.
4. D) it reinterpreted a key provision of the Federal Reserve Act.
Answer: B
90
The Fed's mistakes of the early 1930s were compounded by its decision to
1. A) raise reserve requirements in 1936-1937.
2. B) lower reserve requirements in 1936-1937.
3. C) raise the monetary base in 1936-1937.
4. D) lower the monetary base in 1936-1937.
Answer: A
91
During World War II, whenever interest rates would ________ and the price of bonds would begin
to ________, the Fed would make open market purchases.
1. A) rise; rise
2. B) rise; fall
3. C) fall; rise
4. D) fall; fall
Answer: B
92
During World War II, whenever interest rates would rise and the price of bonds would begin to
fall, the Fed would
1. A) lower reserve requirements.
2. B) raise reserve requirements.
3. C) make open market purchases of government securities.
4. D) make open market sales of government securities.
Answer: C
93
During World War II, the Fed in effect relinquished its control of monetary policy through its
policy of
1. A) continually lowering reserve requirements.
2. B) continually raising reserve requirements.
3. C) pegging interest rates.
4. D) targeting free reserves.
Answer: C
94
The Fed was committed to keeping interest rates low to assist Treasury financing of budget
deficits
1. A) only during World War I.
2. B) during the Great Depression.
3. C) during World War I and World War II.
4. D) throughout the entire existence of the Fed.
Answer: C
95
The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to
1. A) let interest rates increase.
2. B) let unemployment increase.
3. C) let inflation accelerate.
4. D) let exchange rates increase.
Answer: A
96
During the 1950s, the Fed targeted
1. A) M1.
2. B) M2.
3. C) the monetary base.
4. D) money market conditions.
Answer: D
97
During the 1950s, Fed monetary policy targeted
1. A) the monetary base.
2. B) the exchange rate.
3. C) discount loans.
4. D) interest rates.
Answer: D
98
Targeting interest rates can be procyclical because
1. A) an increase in income increases interest rates, causing the Fed to buy bonds,
increasing the monetary base and money supply, leading to further increases in
income.
2. B) an increase in interest rates increases income, causing the Fed to buy bonds,
increasing the monetary base and money supply, leading to further increases in
income.
3. C) an increase in the monetary base increases the money supply, causing the Fed to
buy bonds, increasing the monetary base and money supply, leading to further
increases in income.
4. D) an increase in income increases the monetary base and money supply, causing
the Fed to buy bonds to increase interest rates and income.
Answer: A
99
High inflation can spiral out of control when
1. A) expected inflation increases nominal interest rates, causing the Fed to buy
bonds, increasing the money supply and further increasing inflation.
2. B) expected inflation decreases nominal interest rates, causing the Fed to buy
bonds, increasing the money supply and further increasing inflation.
3. C) expected inflation increases nominal interest rates, causing the Fed to sell bonds,
increasing the money supply and further increasing inflation.
4. D) expected inflation decreases nominal interest rates, causing the Fed to sell
bonds, increasing the money supply and further increasing inflation.
Answer: A
100
In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be
1. A) countercyclical, helping to stabilize the economy.
2. B) procyclical, destabilizing the economy.
3. C) procyclical, helping to stabilize the economy.
4. D) countercyclical, destabilizing the economy.
Answer: B
101
In practice, the Fed's policy of targeting ________ in the 1960s proved to be ________, destabilizing
the economy.
1. A) money market conditions; countercyclical
2. B) money market conditions; procyclical
3. C) monetary aggregates; countercyclical
4. D) monetary aggregates; procyclical
Answer: B
102
Although the Fed professed employment of a monetary aggregate targeting strategy during the
1970s, its behavior suggests that it emphasized
1. A) free-reserve targeting.
2. B) interest-rate targeting.
3. C) a real-bills doctrine.
4. D) price-index targeting.
Answer: B
103
Although the Fed professed employment of ________ targeting during the 1970s, its behavior
suggests that it emphasized ________ targeting.
1. A) free-reserve; interest-rate
2. B) interest-rate; monetary aggregate
3. C) monetary aggregate; interest-rate
4. D) free reserve; monetary aggregate
Answer: C
104
The Fed's use of the federal funds rate as an operating target in the 1970s resulted in
1. A) countercyclical monetary policy.
2. B) too slow growth in M1 throughout the decade.
3. C) procyclical monetary policy.
4. D) too rapid growth in M1 throughout the decade.
Answer: C
105
The Fed's use of the ________ as an operating target in the 1970s resulted in ________ monetary
policy.
1. A) federal funds rate; countercyclical
2. B) federal funds rate; procyclical
3. C) M1 money supply; countercyclical
4. D) M1 money supply; procyclical
Answer: B
106
In the 1970s, the Fed selected an interest rate as an operating target rather than a reserve
aggregate primarily because it
1. A) had no interest in targeting a monetary aggregate, as evidenced by its
unwillingness to target a reserve aggregate.
2. B) was still very concerned with achieving interest rate stability.
3. C) was committed to targeting free reserves.
4. D) was committed to the real bills doctrine.
Answer: B
107
The Fed operating procedures employed between 1979 and 1982 resulted in ________ swings in
the federal funds rate and ________ swings in the M1 growth rate.
1. A) increased; increased
2. B) increased; decreased
3. C) decreased; decreased
4. D) decreased; increased
Answer: A
108
The fluctuations in both money supply growth and the federal funds rate during 1979-1982
suggest that the Fed
1. A) had shifted to borrowed reserves as an operating target.
2. B) had shifted to total reserves as an operating target.
3. C) had shifted to the monetary base as an operating target.
4. D) never intended to target monetary aggregates.
Answer: D
109
Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate
between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an
operating target.
1. A) borrowed reserves
2. B) nonborrowed reserves
3. C) excess reserves
4. D) required reserves
Answer: A
110
The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American
competitiveness, putting pressure on the Fed to pursue a more ________ monetary policy.
1. A) decrease; contractionary
2. B) increase; expansionary
3. C) increase; contractionary
4. D) decrease; expansionary
Answer: D
111
A borrowed reserves target is ________ because increases in income ________ interest rates and
discount loans, causing the Fed to ________ the monetary base, everything else held constant.
1. A) procyclical; increase; increase
2. B) countercyclical; increase; increase
3. C) procyclical; reduce; reduce
4. D) countercyclical; reduce; reduce
Answer: A
112
Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the
1. A) monetary base.
2. B) money supply.
3. C) federal funds interest rate.
4. D) exchange rate.
Answer: C
113
Since the early 1990s, the Fed has conducted monetary policy by setting a target for the
1. A) level of borrowed reserves.
2. B) monetary base.
3. C) federal funds rate.
4. D) inflation rate.
Answer: C
114
The Fed can engage in preemptive strikes against a rise in inflation by ________ the federal funds
interest rate; it can act preemptively against negative demand shocks by ________ the federal
funds interest rate.
1. A) raising; lowering
2. B) raising; raising
3. C) lowering; lowering
4. D) lowering; raising
Answer: A
115
International policy coordination refers to
1. A) central banks in major nations acting without regard to the global consequences
of their policies.
2. B) central banks in major nations pursuing only domestic objectives.
3. C) central banks adopting policies in pursuit of joint objectives.
4. D) central banks all adopting identical policies.
Answer: C
116
The Federal Reserve has been ________ preemptive because of the changing view that monetary
policy has to be ________ looking.
1. A) more; forward
2. B) more; backward
3. C) less; forward
4. D) less; backward
Chapter 16 The Conduct of Monetary Policy:
Strategy and Tactics
16.1 Monetary Targeting
1) Under monetary targeting, a central bank announces
an annual growth rate target for ________.
A) a monetary aggregate
2) During the years 1979 to 1982, the Federal Reserve's
announced policy was monetary targeting. During this
time period the Federal Reserve
B) did not hit any of their monetary targets because it is
believed that controlling the money supply was not the
intent of the Federal Reserve.
3) Compared to the United States, Japan's experience
with monetary targeting performed
A) better with regard to the inflation rate and output
fluctuations.
4) One of the factors that contributed to the success
German policymakers had using a monetary targeting
type policy was that
C) the money target was flexible to allow the
Bundesbank to concentrate on other goals as needed.
5) Which of the following is the best description of the
monetary policy strategy followed by the European
Central Bank (ECB)?
C) The ECB has a hybrid strategy with elements of both
monetary targeting and inflation targeting.
6) Which of the following is an advantage to money
targeting?
A) There is an immediate signal on the achievement
of the target.
7) Which of the following is a disadvantage to
monetary targeting?
A) It relies on a stable money-inflation relationship.
8) If the relationship between the monetary aggregate
and the goal variable is weak, then
D) monetary aggregate targeting will not work.
9) The monetary policy strategy that provides an
immediate signal on target achievement is
B) monetary targeting.
10) The monetary policy strategy that relies on a stable
money-income relationship is
monetary targeting.
16.2 Inflation Targeting
1) The type of monetary policy that is used in Canada,
New Zealand, and the United Kingdom is
B) inflation targeting.
C) targeting with an implicit nominal anchor.
2) Which of the following is NOT an element of
inflation targeting?
C) An information-inclusive approach in which only
monetary aggregates are used in making decisions
about monetary policy
3) The first country to adopt inflation targeting was
C) New Zealand.
4) In both New Zealand and Canada, what has
happened to the unemployment rate since the countries
adopted inflation targeting?
C) The unemployment rate has declined substantially
after a sharp increase.
5) Which of the following is NOT an advantage of
inflation targeting?
C) There is an immediate signal on the achievement
of the target.
6) Which of the following is NOT a disadvantage to
inflation targeting?
D) There is a lack of transparency.
7) The decision by inflation targeters to choose inflation
targets ________ zero reflects the concern of monetary
policymakers that particularly ________ inflation can
have substantial negative effects on real economic
activity.
D) above; low
8) Inflation targets can increase the central bank's
flexibility in responding to declines in aggregate
spending. Declines in aggregate ________ that cause
the inflation rate to fall below the floor of the target
range will automatically stimulate the central bank to
________ monetary policy without fearing that this
action will trigger a rise in inflation expectations.
B) demand; loosen
Explain what inflation targeting is. What are the
advantages and disadvantages of this type of
monetary policy strategy?
Ans:There are five main elements to inflation
targeting: 1. a public announcement of a mediumterm target for the inflation rate;
2. a commitment to price stability as the primary
long-term goal of policy;
3. many variables are used in making decisions
about policy moves;
4. increased transparency about policy strategy with
the public;
5. the central bank has increased accountability for
attaining policy goals.
The advantages of inflation targeting include:
1. the simplicity and clarity of a numerical target for
the inflation rate;
2. does not rely on a stable money-inflation
relationship;
3. there is increased accountability of the central
bank; 4. reduces the effects of inflationary shocks.
The disadvantages of inflation targeting include:
1. there is a delayed signal about the achievement of
the target;
2. it could lead to a rigid rule where the only focus is
the inflation rate (has not happened in practice);
3. if sole focus is the inflation rate, larger output
fluctuations can occur (has not happened in
practice).
Ques Status: Previous Edition
16.3 Monetary Policy with an Implicit Nominal
Anchor
1) The type of monetary policy regime that the Federal
Reserve has been following in recent years can best be
described as
C) policy with an implicit nominal anchor.
2) Estimates suggest that, in the United States economy,
it takes just over ________ for monetary policy to
affect output and just over ________ for monetary
policy to affect the inflation rate.
A) 1 year; 2 years
3) Which of the following is an advantage of the Fed's
"just do it" approach to monetary policy?
A) It does not rely on the money-inflation relationship.
4) Which of the following is NOT a disadvantage of
of the Fed's "just do it" approach to monetary
policy?
D) It relies on a stable money-inflation relationship.
5) When compared to the Fed's ________ anchor
approach, ________ targeting can make the institutional
framework for the conduct of monetary policy more
consistent with democratic principles.
D) implicit; inflation
6) The monetary policy strategy that suffers a lack
of transparency is
D) the implicit nominal anchor.
7) The monetary policy strategy that provides the
least accountability is
D) the implicit nominal anchor.
8) Explain the Federal Reserve's "just do it"
approach to monetary policy. What are the
advantages and disadvantages to this type of
strategy?
Answer: The Federal Reserve doesn't use an explicit
nominal anchor such as a monetary aggregate or the
inflation rate. Its strategy revolves around using an
implicit nominal anchor in the form of an overriding
concern to control inflation in the long run. This
involves forward-looking behavior and "pre-emptive
strikes" by policy actions to prevent inflation. This
forward-looking behavior is necessary because of the
long time lags between monetary policy action and its
impact on inflation.
The advantages of this policy strategy include: 1. it
doesn't rely on a stable money-inflation relationship; 2.
the demonstrated success it has had in the United
States.
The disadvantages of this policy strategy include: 1.
there is a lack of transparency; 2. its success depends on
the individuals in charge of policy; 3. there is low
accountability of the central bank.
Ques Status: Revised
16.4 Tactics: Choosing the Policy Instrument
1) Which of the following is not an operating
instrument?
) Discount rate
2) Which of the following is a potential operating
instrument for the central bank?
A) The monetary base
3) Due to the lack of timely data for the price level and
economic growth, the Fed's strategy
C) uses an intermediate target, such as an interest rate.
4) If the central bank targets a monetary aggregate, it is
likely to lose control over the interest rate because
A) of fluctuations in the demand for reserves.
5) If the Fed pursues a strategy of targeting an interest
rate when fluctuations in money demand are prevalent,
B) fluctuations of nonborrowed reserves will be large.
6) Fluctuations in the demand for reserves cause the
Fed to lose control over a monetary aggregate if the Fed
targets
C) an interest rate.
7) Interest rates are difficult to measure because
B) real interest rates depend on the hard-to-determine
expected inflation rate.
8) Which of the following criteria need not be satisfied
for choosing an intermediate target?
D) The variable must be transportable.
9) Which of the following is not a requirement in
selecting an intermediate target?
C) Flexibility
10) When it comes to choosing an policy instrument,
both the ________ rate and ________ aggregates are
measured accurately and are available daily with almost
no delay.
D) federal funds; reserve
11) If the desired intermediate target is an interest rate,
then the preferred policy instrument will be a(n)
________ variable like the ________.
B) interest rate; federal funds rate
12) If the desired intermediate target is a monetary
aggregate, then the preferred policy instrument will be
a(n) ________ variable like the ________.
C) reserve aggregate; monetary base
13) If the desired intermediate target is a monetary
aggregate, which of the following would be the most
preferred policy instrument?
D) The monetary base
14) If the desired intermediate target is an interest rate,
the preferred policy instrument would be
A) the federal funds rate.
15) Explain and demonstrate graphically how targeting
nonborrowed reserves can result in federal funds rate
instability.
Answer: See figure below
When nonborrowed reserves are held constant, increases in the demand for reserves result in the
federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the
federal funds rate declining. Since fluctuations in demand do not cause monetary policy actions, the
result is the federal funds rate will fluctuate (assuming the equilibrium federal
funds rate is below the discount rate).
16) Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in
nonborrowed reserves.
Answer: See figure below
With a federal funds rate target, fluctuations in demand
for reserves require similar changes in the nonborrowed
reserves to keep the federal funds rate constant.
Ques Status: Revised
16.5 Tactics: The Taylor Rule
1) According to the Taylor rule, the Fed should raise the
federal funds interest rate when inflation ________ the
Fed's inflation target or when real GDP ________ the
Fed's output target.
C) rises above; rises above
2) Using Taylor's rule, when the equilibrium real federal
funds rate is 3 percent, the positive output gap is 2
percent, the target inflation rate is 1 percent, and the
actual inflation rate is 2 percent, the nominal federal
funds rate target should be
D) 6.5 percent.
3) Using Taylor's rule, when the equilibrium real federal
funds rate is 2 percent, there is no output gap, the actual
inflation rate is zero, and the target inflation rate is 2
percent, the nominal federal funds rate should be
B) 1 percent.
4) According to the Taylor Principle, when the inflation
rate rises, the nominal interest rate should be ________
by ________ than the inflation rate increase.
A) increased; more
5) If the Taylor Principle is not followed and nominal
interest rates are increased by less than the increase in
the inflation rate, then real interest rates will ________
and monetary policy will be too ________.
D) fall; loose
6) The rate of inflation tends to remain constant when
B) the unemployment rate equals the NAIRU.
7) The rate of inflation increases when
C) the unemployment rate is less than the NAIRU.
8) Explain the Taylor rule, including the formula for
setting the federal funds rate target, and the components
of the formula. If the Fed were to use this rule, how
many goals would it use to set monetary policy?
Answer: The Taylor rule specifies that the target
federal fund rates should be set to equal the equilibrium
real federal funds rate, plus the rate of inflation (for the
Fisher effect), plus one-half times the output gap, plus
one-half times the inflation gap. The formula is
Federal funds rate target = equilibrium real federal
funds rate + inflation rate +
2
1
(output gap) +
2
1
(inflation gap)
The output gap is the percentage deviation of real GDP
from potential full-employment real GDP. The inflation
gap is the difference between actual inflation and the
central bank's target rate of inflation. The equilibrium
real federal funds rate is the real rate consistent with
full employment in the long run. The inflation rate is
the actual rate of inflation. The Taylor rule sets the
federal funds rate recognizing the goals of low inflation
and full employment (or equilibrium long-run economic
growth).
Ques Status: Previous Edition
16.6 Central Banks' Response to Asset-Price
Bubbles: Lessons From The Subprime Crisis
1) When asset prices increase above their fundamental
values it is called an ________.
A) asset-price bubble
2) Suppose interest rates are kept very low for a long
time such that there is a spike in the amount of lending.
Everything else held constant, this could cause
________ bubble.
B) a credit-driven
3) A credit-driven bubble arises when ________ in
lending causes ________ in asset prices which can
cause ________ in lending.
C) an increase; an increase; a further increase
4) ________ bubble is driven entirely by unrealistic
optimistic expectations.
A) An irrational exuberance
5) Everything else held constant, a credit-drive bubble
is generally considered to have the potential to cause
________ damage to an economy compared to an
irrational exuberance bubble.
C) more
6) A central bank has ________ chance to identify a
credit-driven bubble compared to an irrational
exuberance bubble.
A) a greater
7) Which of the following is NOT an argument against
using monetary policy to prick asset-price bubbles?
aggregate economy.
D) Even though credit-drive bubbles are easier to
identify, they are still relatively hard to identify.
16.7 Fed Policy Procedures: Historical Perspective
1) In its earliest years, the Federal Reserve's guiding
principle for the conduct of monetary policy was known
as the
A) real bills doctrine.
2) The guiding principle for the conduct of monetary
policy that held that as long as loans were being made
for "productive" purposes, then providing reserves to
the banking system to make these loans would not be
inflationary became known as the
D) real bills doctrine.
3) The real bills doctrine was the guiding principle for
the conduct of monetary policy during the
A) 1910s.
4) The Fed accidentally discovered open market
operations in the early
A) 1920s.
5) The Fed accidentally discovered open market
operations when
B) it purchased securities for income following the
1920-1921 recession.
6) The Fed's mistakes of the early 1930s were
compounded by its decision to
A) raise reserve requirements in 1936-1937.
7) During World War II, whenever interest rates would
________ and the price of bonds would begin to
________, the Fed would make open market purchases.
B) rise; fall
8) During World War II, whenever interest rates would
rise and the price of bonds would begin to fall, the Fed
would
C) make open market purchases of government
securities.
9) During World War II, the Fed in effect relinquished
its control of monetary policy through its policy of
C) pegging interest rates.
10) The Fed was committed to keeping interest rates
low to assist Treasury financing of budget deficits
C) during World War I and World War II.
11) The Fed-Treasury Accord of March 1951 provided
the Fed greater freedom to
A) let interest rates increase.
12) During the 1950s, the Fed targeted
D) money market conditions.
13) During the 1950s, Fed monetary policy targeted
D) interest rates.
14) Targeting interest rates can be procyclical because
A) an increase in income increases interest rates,
causing the Fed to buy bonds, increasing the monetary
base and money supply, leading to further increases in
income.
15) High inflation can spiral out of control when
A) expected inflation increases nominal interest rates,
causing the Fed to buy bonds, increasing the money
supply and further increasing inflation.
16) In practice, the Fed's policy of targeting money
market conditions in the 1960s proved to be
B) procyclical, destabilizing the economy.
17) In practice, the Fed's policy of targeting ________
in the 1960s proved to be ________, destabilizing the
economy.
B) money market conditions; procyclical
18) Although the Fed professed employment of a
monetary aggregate targeting strategy during the 1970s,
its behavior suggests that it emphasized
B) interest-rate targeting.
19) Although the Fed professed employment of
________ targeting during the 1970s, its behavior
suggests that it emphasized ________ targeting
C) monetary aggregate; interest-rate
20) The Fed's use of the federal funds rate as an
operating target in the 1970s resulted in
C) procyclical monetary policy.
21) The Fed's use of the ________ as an operating
target in the 1970s resulted in ________ monetary
policy.
B) federal funds rate; procyclical
22) In the 1970s, the Fed selected an interest rate as an
operating target rather than a reserve aggregate
primarily because it
B) was still very concerned with achieving interest rate
stability.
23) The Fed operating procedures employed between
1979 and 1982 resulted in ________ swings in the
federal funds rate and ________ swings in the M1
growth rate.
A) increased; increased
24) The fluctuations in both money supply growth and
the federal funds rate during 1979-1982 suggest that the
Fed
D) never intended to target monetary aggregates.
25) The Fed's failure to exercise effective control over
the money supply during the 1979-1982 period
C) occurred despite evidence of a strong link between
open market operations and the money supply.
26) Large fluctuations in money supply growth and
smaller fluctuations in the federal funds rate between
October 1982 and the early 1990s indicate that the Fed
had shifted to ________ as an operating target.
A) borrowed reserves
27) The strengthening of the dollar between 1980 and
1985 contributed to a ________ in American
competitiveness, putting pressure on the Fed to pursue a
more ________ monetary policy.
D) decrease; expansionary
28) A borrowed reserves target is ________ because
increases in income ________ interest rates and
discount loans, causing the Fed to ________ the
monetary base, everything else held constant.
A) procyclical; increase; increase
29) Fed policy since the early 1990s indicates that it is
pursuing a policy of targeting the
C) federal funds interest rate.
30) Since the early 1990s, the Fed has conducted
monetary policy by setting a target for the
C) federal funds rate.
31) The Fed can engage in preemptive strikes against a
rise in inflation by ________ the federal funds interest
rate; it can act preemptively against negative demand
shocks by ________ the federal funds interest rate.
A) raising; lowering
16.8 International Considerations
1) International policy coordination refers to
C) central banks adopting policies in pursuit of joint
objectives.
2) The Federal Reserve has been ________ preemptive
because of the changing view that monetary policy has
to be ________ looking.
A) more; forwar
Chapter 17 The Foreign Exchange Market
17.1 Foreign Exchange Market
1) The exchange rate is
A) the price of one currency relative to gold.
B) the value of a currency relative to inflation.
C) the change in the value of money over time.
D) the price of one currency relative to another.
Answer: D
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2) Exchange rates are determined in
A) the money market.
B) the foreign exchange market.
C) the stock market.
D) the capital market.
Answer: B
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3) Although foreign exchange market trades are said to involve the buying and selling of
currencies, most trades involve the buying and selling of
A) bank deposits denominated in different currencies.
B) SDRs.
C) gold.
D) ECUs.
Answer: A
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4) The immediate (two-day) exchange of one currency for another is a
A) forward transaction.
B) spot transaction.
C) money transaction.
D) exchange transaction.
Answer: B
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5) An agreement to exchange dollar bank deposits for euro bank deposits in one month is a
A) spot transaction.
B) future transaction.
C) forward transaction.
D) deposit transaction.
Answer: C
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6) Today 1 euro can be purchased for $1.10. This is the
A) spot exchange rate.
B) forward exchange rate.
C) fixed exchange rate.
D) financial exchange rate.
Answer: A
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7) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the
price is the
A) spot exchange rate.
B) money exchange rate.
C) forward exchange rate.
D) fixed exchange rate.
Answer: C
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8) When the value of the British pound changes from $1.25 to $1.50, the pound has ________
and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
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9) When the value of the British pound changes from $1.50 to $1.25, then the pound has
________ and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
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10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has
________ and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
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11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has
________ and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
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12) When the exchange rate for the Mexican peso changes from 9 pesos to the U.S. dollar to 10
pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
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13) When the exchange rate for the Mexican peso changes from 10 pesos to the U.S dollar to 9
pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
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14) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 0.75
euros. Therefore, one euro would have purchased about ________ U.S. dollars.
A) 0.75
B) 1.00
C) 1.33
D) 1.75
Answer: C
Ques Status: Revised
15) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 49.0
Indian rupees. Thus, one Indian rupee would have purchased about ________ U.S. dollars.
A) 0.02
B) 1.20
C) 7.00
D) 49.0
Answer: A
Ques Status: Revised
16) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 1.15
Swiss francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars.
A) 0.30
B) 0.87
C) 1.15
D) 3.10
Answer: B
Ques Status: Revised
17) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 3.33
Romanian new lei. Therefore, one Romanian new lei would have purchased about ________
U.S. dollars.
A) 0.30
B) 1.86
C) 2.86
D) 3.33
Answer: A
Ques Status: Revised
18) If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar,
then the franc depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per
franc.
A) 0.80; 0.67
B) 0.67; 0.80
C) 0.50; 0.33
D) 0.33; 0.50
Answer: A
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19) If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar
depreciates from ________ per dollar to ________ per dollar.
A) £2; £2.5
B) £2; £1.33
C) £2; £1.5
D) £2; £1.25
Answer: B
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20) If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar
depreciates from ________ per dollar to ________ per dollar.
A) 100¥; 50¥
B) 10¥; 5¥
C) 5¥; 10¥
D) 50¥; 100¥
Answer: A
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21) If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real
depreciates from ________ per real to ________ per real.
A) $0.67; $0.50
B) $0.33; $0.50
C) $0.75; $0.50
D) $0.50; $0.67
E) $0.50; $0.75
Answer: A
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22) When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per
pound, then, holding everything else constant, the pound has ________ and ________ expensive.
A) appreciated; British cars sold in the United States become more
B) appreciated; British cars sold in the United States become less
C) depreciated; American wheat sold in Britain becomes more
D) depreciated; American wheat sold in Britain becomes less
Answer: C
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23) If the dollar depreciates relative to the Swiss franc
A) Swiss chocolate will become cheaper in the United States.
B) American computers will become more expensive in Switzerland.
C) Swiss chocolate will become more expensive in the United States.
D) Swiss computers will become cheaper in the United States.
Answer: C
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24) Everything else held constant, when a country's currency appreciates, the country's goods
abroad become ________ expensive and foreign goods in that country become ________
expensive.
A) more; less
B) more; more
C) less; less
D) less; more
Answer: A
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25) Everything else held constant, when a country's currency depreciates, its goods abroad
become ________ expensive while foreign goods in that country become ________ expensive.
A) more; less
B) more; more
C) less; less
D) less; more
Answer: D
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17.2 Exchange Rates in the Long Run
1) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos
per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate
between the Colombian peso and the Brazilian real is:
A) 40 pesos per real.
B) 100 pesos per real.
C) 25 pesos per real.
D) 0.4 pesos per real.
Answer: C
Ques Status: Revised
2) The starting point for understanding how exchange rates are determined is a simple idea called
________, which states: if two countries produce an identical good, the price of the good should
be the same throughout the world no matter which country produces it.
A) Gresham's law
B) the law of one price
C) purchasing power parity
D) arbitrage
Answer: B
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3) The ________ states that exchange rates between any two currencies will adjust to reflect
changes in the price levels of the two countries.
A) theory of purchasing power parity
B) law of one price
C) theory of money neutrality
D) quantity theory of money
Answer: A
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4) The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should
A) depreciate.
B) appreciate.
C) float.
D) do none of the above.
Answer: A
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5) The theory of PPP suggests that if one country's price level falls relative to another's, its
currency should
A) depreciate.
B) appreciate.
C) float.
D) do none of the above.
Answer: B
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6) The theory of PPP suggests that if one country's price level falls relative to another's, its
currency should
A) depreciate in the long run.
B) appreciate in the long run.
C) appreciate in the short run.
D) depreciate in the short run.
Answer: B
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7) The theory of purchasing power parity cannot fully explain exchange rate movements because
A) all goods are identical even if produced in different countries.
B) monetary policy differs across countries.
C) some goods are not traded between countries.
D) fiscal policy differs across countries.
Answer: C
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8) The theory of purchasing power parity states that exchange rates between any two currencies
will adjust to reflect changes in
A) the trade balances of the two countries.
B) the current account balances of the two countries.
C) fiscal policies of the two countries.
D) the price levels of the two countries.
Answer: D
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9) If the real exchange rate between the United States and Japan is ________, then it is cheaper
to buy goods in Japan than in the United States.
A) greater than 1.0
B) greater than 0.5
C) less than 0.5
D) less than 1.0
Answer: A
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10) According to PPP, the real exchange rate between two countries will always equal ________.
A) 0.0
B) 0.5
C) 1.0
D) 1.5
Answer: C
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11) The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should
A) depreciate in the long run.
B) appreciate in the long run.
C) depreciate in the short run.
D) appreciate in the short run.
Answer: A
Ques Status: Previous Edition
12) In the long run, a rise in a country's price level (relative to the foreign price level) causes its
currency to ________, while a fall in the country's relative price level causes its currency to
________.
A) appreciate; appreciate
B) appreciate; depreciate
C) depreciate; appreciate
D) depreciate; depreciate
Answer: C
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13) If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent,
then the theory of purchasing power parity predicts that, during 2005, the value of the Canadian
dollar in terms of Mexican pesos will
A) rise by 6 percent.
B) rise by 2 percent.
C) fall by 6 percent.
D) fall by 2 percent.
Answer: D
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14) Assume that the following are the predicted inflation rates in these countries for the year: 2%
for the United States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the
purchasing power parity and everything else held constant, which of the following would we
expect to happen?
A) The Brazilian real will depreciate against the U.S. dollar.
B) The Mexican peso will depreciate against the Brazilian real.
C) The Canadian dollar will depreciate against the Mexican peso.
D) The U.S. dollar will depreciate against the Canadian dollar.
Answer: A
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15) According to the purchasing power parity theory, a rise in the United States price level of 5
percent, and a rise in the Mexican price level of 6 percent cause
A) the dollar to appreciate 1 percent relative to the peso.
B) the dollar to depreciate 1 percent relative to the peso.
C) the dollar to depreciate 5 percent relative to the peso.
D) the dollar to appreciate 5 percent relative to the peso.
Answer: A
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16) Higher tariffs and quotas cause a country's currency to ________ in the ________ run,
everything else held constant.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: D
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17) Lower tariffs and quotas cause a country's currency to ________ in the ________ run,
everything else held constant.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: C
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18) Anything that increases the demand for foreign goods relative to domestic goods tends to
________ the domestic currency because domestic goods will only continue to sell well if the
value of the domestic currency is ________, everything else held constant.
A) depreciate; lower
B) depreciate; higher
C) appreciate; lower
D) appreciate; higher
Answer: A
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19) Everything else held constant, increased demand for a country's ________ causes its
currency to appreciate in the long run, while increased demand for ________ causes its currency
to depreciate.
A) imports; imports
B) imports; exports
C) exports; imports
D) exports; exports
Answer: C
Ques Status: Previous Edition
20) Everything else held constant, increased demand for a country's exports causes its currency
to ________ in the long run, while increased demand for imports causes its currency to
________.
A) appreciate; appreciate
B) appreciate; depreciate
C) depreciate; appreciate
D) depreciate; depreciate
Answer: B
Ques Status: Revised
21) Everything else held constant, if a factor increases the demand for ________ goods relative
to ________ goods, the domestic currency will appreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Answer: D
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22) Everything else held constant, if a factor decreases the demand for ________ goods relative
to ________ goods, the domestic currency will depreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Answer: D
Ques Status: Previous Edition
23) An increase in productivity in a country will cause its currency to ________ because it can
produce goods at a ________ price, everything else held constant.
A) depreciate; lower
B) appreciate; lower
C) depreciate; higher
D) appreciate; higher
Answer: B
Ques Status: Previous Edition
24) If, in retaliation for "unfair" trade practices, Congress imposes a 30 percent tariff on Japanese
DVD recorders, but at the same time, U.S. demand for Japanese goods increases, then, in the
long run, ________, everything else held constant
A) the Japanese yen should appreciate relative to the U.S. dollar
B) the Japanese yen should depreciate relative to the U.S. dollar
C) there is no effect on the Japanese yen relative to the U.S. dollar
D) the Japanese yen could appreciate, depreciate or remain constant relative to the U.S. dollar
Answer: D
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25) If the U.S. Congress imposes a quota on imports of Japanese cars due to claims of "unfair"
trade practices, and Japanese demand for American exports increases at the same time, then, in
the long run ________, everything else held constant.
A) the Japanese yen will appreciate relative to the U.S. dollar
B) the Japanese yen will depreciate relative to the U.S. dollar
C) the Japanese yen will either appreciate, depreciate or remain constant against the U.S. dollar
D) there will be no effect on the Japanese yen relative to the U.S. dollar
Answer: B
Ques Status: Previous Edition
26) If the inflation rate in the United States is higher than that in Mexico and productivity is
growing at a slower rate in the United States than in Mexico, then, in the long run, ________,
everything else held constant.
A) the Mexican peso will appreciate relative to the U.S. dollar
B) the Mexican peso will depreciate relative to the U.S. dollar
C) the Mexican peso will either appreciate, depreciate, or remain constant relative to the U.S.
dollar
D) there will be no effect on the Mexican peso relative to the U.S. dollar
Answer: A
Ques Status: Previous Edition
27) If the Brazilian demand for American exports rises at the same time that U.S. productivity
rises relative to Brazilian productivity, then, in the long run, ________, everything else held
constant.
A) the Brazilian real will appreciate relative to the U.S. dollar
B) the Brazilian real will depreciate relative to the U.S. dollar
C) the Brazilian real will either appreciate, depreciate, or remain constant relative to the U.S.
dollar
D) there is no effect on the Brazilian real relative to the U.S. dollar
Answer: B
Ques Status: Previous Edition
28) Explain the law of one price and the theory of purchasing power parity. Why doesn't
purchasing power parity explain all exchange rate movements? What factors determine long-run
exchange rates?
Answer: With no trade barriers and low transport costs, the law of one price states that the price
of traded goods should be the same in all countries. The purchasing power parity theory extends
the law of one price to total economies. PPP states that exchange rates should adjust to reflect
changes in the price levels between two countries. PPP may fail to fully explain exchange rates
because goods are not identical, and price levels include traded and nontraded goods and
services. Long-run exchange rates are determined by domestic price levels relative to foreign
price levels, trade barriers, import and export demand, and productivity.
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17.3 Exchange Rates in the Short Run: A Supply and Demand Analysis
1) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is
A) the level of trade and capital flows.
B) the expected return on these assets relative to one another.
C) the liquidity of these assets relative to one another.
D) the riskiness of these assets relative to one another.
Answer: B
Ques Status: Previous Edition
2) The ________ suggests that the most important factor affecting the demand for domestic and
foreign assets is the expected return on domestic assets relative to foreign assets.
A) theory of asset demand
B) law of one price
C) interest parity condition
D) theory of foreign capital mobility
Answer: A
Ques Status: Previous Edition
3) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is the ________ on these assets relative to one another.
A) interest rate
B) risk
C) expected return
D) liquidity
Answer: C
Ques Status: Previous Edition
4) As the relative expected return on dollar assets increases, foreigners will want to hold more
________ assets and less ________ assets, everything else held constant.
A) foreign; foreign
B) foreign; dollar
C) dollar; foreign
D) dollar; dollar
Answer: C
Ques Status: Previous Edition
5) When Americans or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a higher demand for dollar assets and a correspondingly
lower demand for foreign assets.
A) dollar; dollar
B) dollar; foreign
C) foreign; dollar
D) foreign; foreign
Answer: B
Ques Status: Previous Edition
6) When Americans or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a ________ demand for dollar assets, everything else held
constant.
A) dollar; foreign; constant
B) dollar; foreign; higher
C) foreign; dollar; higher
D) foreign; dollar; constant
Answer: B
Ques Status: Previous Edition
7) When Americans or foreigners expect the return on dollar assets to be high relative to the
return on foreign assets, there is a ________ demand for dollar assets and a correspondingly
________ demand for foreign assets.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
Answer: B
Ques Status: Revised
8) Everything else held constant, when the current value of the domestic currency increases, the
________ domestic assets ________.
A) demand for; increases
B) quantity demanded of; increases
C) demand for; decreases
D) quantity demanded of; decreases
Answer: D
Ques Status: Previous Edition
9) Everything else held constant, when the current value of the domestic exchange rate increases,
the ________ of domestic assets ________.
A) quantity supplied; does not change
B) supply; decreases
C) quantity supplied; increases
D) supply; increases
Answer: A
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17.4 Explaining Changes in Exchange Rates
1) An increase in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
2) An increase in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: Previous Edition
3) A decrease in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
4) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: Previous Edition
5) ________ in the domestic interest rate causes the demand for domestic assets to increase and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: Previous Edition
6) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
right and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: Previous Edition
7) ________ in the domestic interest rate causes the demand for domestic assets to decrease and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: Previous Edition
8) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
left and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: Previous Edition
9) ________ in the domestic interest rate causes the demand for domestic assets to ________ and
the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Ques Status: Previous Edition
10) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Ques Status: Previous Edition
11) ________ in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Ques Status: Previous Edition
12) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to depreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: D
Ques Status: Previous Edition
13) Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant,
this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
14) Suppose that the Federal Reserve conducts an open market sale. Everything else held
constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar will
________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
15) An increase in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
16) An increase in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: Previous Edition
17) A decrease in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
18) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: Previous Edition
19) ________ in the foreign interest rate causes the demand for domestic assets to increase and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: C
Ques Status: Previous Edition
20) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
right and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: C
Ques Status: Previous Edition
21) ________ in the foreign interest rate causes the demand for domestic assets to decrease and
the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: B
Ques Status: Previous Edition
22) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left
and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: B
Ques Status: Previous Edition
23) ________ in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: C
Ques Status: Previous Edition
24) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: C
Ques Status: Previous Edition
25) ________ in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: B
Ques Status: Previous Edition
26) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to depreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: B
Ques Status: Previous Edition
27) Suppose that the European Central Bank enacts expansionary policy. Everything else held
constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar to
________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
28) Suppose that the European Central Bank conducts a main refinancing sale. Everything else
held constant, this would cause the demand for U.S. assets to ________ and the U.S. dollar will
________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
29) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
30) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Ques Status: Previous Edition
31) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
32) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Ques Status: Previous Edition
33) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to increase and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: Previous Edition
34) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the right and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: A
Ques Status: Previous Edition
35) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to decrease and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: Previous Edition
36) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the left and the domestic currency to ________, everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Answer: D
Ques Status: Previous Edition
37) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Ques Status: Previous Edition
38) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to appreciate, everything else held
constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Ques Status: Previous Edition
39) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Ques Status: Previous Edition
40) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to depreciate, everything else held
constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: D
Ques Status: Previous Edition
41) Suppose the Federal Reserve releases a policy statement today which leads people to believe
that the Fed will be enacting expansionary monetary policy in the near future. Everything else
held constant, the release of this statement would immediately cause the demand for U.S. assets
to ________ and the U.S. dollar to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
42) Suppose a report was released today that showed the Euro-Zone inflation rate is running
above the European Central Bank's inflation rate target. This leads people to expect that the
European Central Bank will enact contractionary policy in the near future. Everything else held
constant, the release of this report would immediately cause the demand for U.S. assets to
________ and the U.S. dollar will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Ques Status: Previous Edition
43) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in
the U.S. than was expected. Everything else held constant, the release of the CPI report would
immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Ques Status: Previous Edition
44) In the long run, a one-time percentage increase in the money supply is matched by the same
one-time percentage rise in the price level, leaving unchanged the real money supply and
________. This proposition is called money ________.
A) other economic variables such as interest rates; neutrality
B) the nominal exchange rate; neutrality
C) all other economic variables such as interest rates; illusion
D) the nominal exchange rate; illusion
Answer: A
Ques Status: Previous Edition
45) Money neutrality means that in the long run the domestic interest rate remains unchanged
from an increase in the money supply, implying that the fall in the exchange rate is greater in the
________ run than in the ________ run, a phenomenon called exchange rate overshooting.
A) short; short
B) short; long
C) long; short
D) long; long
Answer: B
Ques Status: Previous Edition
46) Evidence from the United States during the period 1973-2002 indicates that the value of the
dollar and the measure of the ________ interest rate rose and fell together.
A) real
B) nominal
C) expected
D) actual
Answer: A
Ques Status: Previous Edition
47) During the beginning on the subprime crisis in the United States when the effects of the crisis
were mostly confined within the United States, the U. S. dollar ________ because demand for
U.S. assets ________.
A) appreciated; increased
B) depreciated; increased
C) appreciated; decreased
D) depreciated; decreased
Answer: D
Ques Status: New
48) When the effects of the subprime crisis started to spread more quickly throughout the rest of
the world, the U.S. dollar ________ because demand for U.S. assets ________.
A) appreciated; increased
B) depreciated; increased
C) appreciated; decreased
D) depreciated; decreased
Answer: A
Ques Status: New
17.5 APPENDIX: The Interest Parity Condition
1) The condition that states that the domestic interest rate equals the foreign interest rate minus
the expected appreciation of the domestic currency is called
A) the purchasing power parity condition.
B) the interest parity condition.
C) money neutrality.
D) the theory of foreign capital mobility.
Answer: B
Ques Status: Previous Edition
2) If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, for Francois the
Frenchman the expected rate of return on dollar-denominated assets is
A) 11 percent.
B) 9 percent.
C) 5 percent.
D) 3 percent.
E) 1 percent.
Answer: B
Ques Status: Previous Edition
3) If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected
return on ________-denominated assets in ________ percent.
A) dollar; euros is 3
B) euro; dollars is 1
C) dollar; euros is 1
D) euro; dollars is 3
Answer: D
Ques Status: Previous Edition
4) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on pesodenominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Manuel the
Mexican the expected rate of return on euro-denominated assets is
A) 11 percent.
B) 13 percent.
C) 17 percent.
D) 19 percent.
Answer: C
Ques Status: Previous Edition
5) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on pesodenominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Francois the
Frenchman the expected rate of return on peso-denominated assets is
A) 11 percent.
B) 15 percent.
C) 17 percent.
D) 19 percent.
Answer: A
Ques Status: Previous Edition
6) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the foreign currency is
A) 3 percent.
B) 10 percent.
C) 13.5 percent.
D) 17 percent.
Answer: D
Ques Status: Previous Edition
7) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the dollar is
A) 3 percent.
B) 10 percent.
C) 13.5 percent.
D) 17 percent.
Answer: B
Ques Status: Previous Edition
8) The expected return on dollar deposits in terms of foreign currency can be written as the
________ of the interest rate on dollar deposits and the expected appreciation of the dollar.
A) product
B) ratio
C) sum
D) difference
Answer: C
Ques Status: Previous Edition
9) In a world with few impediments to capital mobility, the domestic interest rate equals the sum
of the foreign interest rate and the expected depreciation of the domestic currency, a situation
known as the
A) interest parity condition.
B) purchasing power parity condition.
C) exchange rate parity condition.
D) foreign asset parity condition.
Answer: A
Ques Status: Previous Edition
10) According to the interest parity condition, if the domestic interest rate is 12 percent and the
foreign interest rate is 10 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: B
Ques Status: Previous Edition
11) According to the interest parity condition, if the domestic interest rate is 10 percent and the
foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: C
Ques Status: Previous Edition
1
The exchange rate is
1. A) the price of one currency relative to gold.
2. B) the value of a currency relative to inflation.
3. C) the change in the value of money over time.
4. D) the price of one currency relative to another.
Answer: D
2
Exchange rates are determined in
1. A) the money market.
2. B) the foreign exchange market.
3. C) the stock market.
4. D) the capital market.
Answer: B
3
Although foreign exchange market trades are said to involve the buying and selling of
currencies, most trades involve the buying and selling of
1. A) bank deposits denominated in different currencies.
2. B) SDRs.
3. C) gold.
4. D) ECUs.
Answer: A
4
The immediate (two-day) exchange of one currency for another is a
1. A) forward transaction.
2. B) spot transaction.
3. C) money transaction.
4. D) exchange transaction.
Answer: B
5
An agreement to exchange dollar bank deposits for euro bank deposits in one month is a
1. A) spot transaction.
2. B) future transaction.
3. C) forward transaction.
4. D) deposit transaction.
Answer: C
6
Today 1 euro can be purchased for $1.10. This is the
1. A) spot exchange rate.
2. B) forward exchange rate.
3. C) fixed exchange rate.
4. D) financial exchange rate.
Answer: A
7
In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the
price is the
1. A) spot exchange rate.
2. B) money exchange rate.
3. C) forward exchange rate.
4. D) fixed exchange rate.
Answer: C
8
When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and
the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: C
9
When the value of the British pound changes from $1.50 to $1.25, then the pound has ________
and the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: B
10
When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and
the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: B
11
When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and
the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: C
12
When the exchange rate for the Mexican peso changes from 9 pesos to the U.S. dollar to 10
pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: B
13
When the exchange rate for the Mexican peso changes from 10 pesos to the U.S dollar to 9
pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.
1. A) appreciated; appreciated
2. B) depreciated; appreciated
3. C) appreciated; depreciated
4. D) depreciated; depreciated
Answer: C
14
On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 0.75
euros. Therefore, one euro would have purchased about ________ U.S. dollars.
1. A) 0.75
2. B) 1.00
3. C) 1.33
4. D) 1.75
Answer: C
15
On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 49.0
Indian rupees. Thus, one Indian rupee would have purchased about ________ U.S. dollars.
1. A) 0.02
2. B) 1.20
3. C) 7.00
4. D) 49.0
Answer: A
16
On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 1.15 Swiss
francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars.
1. A) 0.30
2. B) 0.87
3. C) 1.15
4. D) 3.10
Answer: B
17
On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 3.33
Romanian new lei. Therefore, one Romanian new lei would have purchased about ________ U.S.
dollars.
1. A) 0.30
2. B) 1.86
3. C) 2.86
4. D) 3.33
Answer: A
18
If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar, then
the franc depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per franc.
1. A) 0.80; 0.67
2. B) 0.67; 0.80
3. C) 0.50; 0.33
4. D) 0.33; 0.50
Answer: A
19
If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar
depreciates from ________ per dollar to ________ per dollar.
1. A) £2; £2.5
2. B) £2; £1.33
3. C) £2; £1.5
4. D) £2; £1.25
Answer: B
20
If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar depreciates
from ________ per dollar to ________ per dollar.
1. A) 100¥; 50¥
2. B) 10¥; 5¥
3. C) 5¥; 10¥
4. D) 50¥; 100¥
Answer: A
21
If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real
depreciates from ________ per real to ________ per real.
1. A) $0.67; $0.50
2. B) $0.33; $0.50
3. C) $0.75; $0.50
4. D) $0.50; $0.67
5. E) $0.50; $0.75
Answer: A
22
When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per
pound, then, holding everything else constant, the pound has ________ and ________ expensive.
1. A) appreciated; British cars sold in the United States become more
2. B) appreciated; British cars sold in the United States become less
3. C) depreciated; American wheat sold in Britain becomes more
4. D) depreciated; American wheat sold in Britain becomes less
Answer: C
23
If the dollar depreciates relative to the Swiss franc
1. A) Swiss chocolate will become cheaper in the United States.
2. B) American computers will become more expensive in Switzerland.
3. C) Swiss chocolate will become more expensive in the United States.
4. D) Swiss computers will become cheaper in the United States.
Answer: C
24
Everything else held constant, when a country's currency appreciates, the country's goods
abroad become ________ expensive and foreign goods in that country become ________ expensive.
1. A) more; less
2. B) more; more
3. C) less; less
4. D) less; more
Answer: A
25
Everything else held constant, when a country's currency depreciates, its goods abroad become
________ expensive while foreign goods in that country become ________ expensive.
1. A) more; less
2. B) more; more
3. C) less; less
4. D) less; more
Answer: D
26
According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per
pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate
between the Colombian peso and the Brazilian real is
1. A) 40 pesos per real.
2. B) 100 pesos per real.
3. C) 25 pesos per real.
4. D) 0.4 pesos per real.
Answer: C
27
The starting point for understanding how exchange rates are determined is a simple idea called
________, which states: if two countries produce an identical good, the price of the good should
be the same throughout the world no matter which country produces it.
1. A) Gresham's law
2. B) the law of one price
3. C) purchasing power parity
4. D) arbitrage
Answer: B
28
The ________ states that exchange rates between any two currencies will adjust to reflect changes
in the price levels of the two countries.
1. A) theory of purchasing power parity
2. B) law of one price
3. C) theory of money neutrality
4. D) quantity theory of money
Answer: A
29
The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should
1. A) depreciate.
2. B) appreciate.
3. C) float.
4. D) do none of the above.
Answer: A
30
The theory of PPP suggests that if one country's price level falls relative to another's, its currency
should
1. A) depreciate.
2. B) appreciate.
3. C) float.
4. D) do none of the above.
Answer: B
31
The theory of PPP suggests that if one country's price level falls relative to another's, its currency
should
1. A) depreciate in the long run.
2. B) appreciate in the long run.
3. C) appreciate in the short run.
4. D) depreciate in the short run.
Answer: B
32
The theory of purchasing power parity cannot fully explain exchange rate movements in the
short run because
1. A) all goods are identical even if produced in different countries.
2. B) monetary policy differs across countries.
3. C) some goods are not traded between countries.
4. D) fiscal policy differs across countries.
Answer: C
33
The theory of purchasing power parity states that exchange rates between any two currencies
will adjust to reflect changes in
1. A) the trade balances of the two countries.
2. B) the current account balances of the two countries.
3. C) fiscal policies of the two countries.
4. D) the price levels of the two countries.
Answer: D
34
If the real exchange rate between the United States and Japan is ________, then it is cheaper to
buy goods in Japan than in the United States.
1. A) greater than 1.0
2. B) greater than 0.5
3. C) less than 0.5
4. D) less than 1.0
Answer: A
35
According to PPP, the real exchange rate between two countries will always equal
1. A) 0.0.
2. B) 0.5.
3. C) 1.0.
4. D) 1.5.
Answer: C
36
The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should
1. A) depreciate in the long run.
2. B) appreciate in the long run.
3. C) depreciate in the short run.
4. D) appreciate in the short run.
Answer: A
37
In the long run, a rise in a country's price level (relative to the foreign price level) causes its
currency to ________, while a fall in the country's relative price level causes its currency to ________.
1. A) appreciate; appreciate
2. B) appreciate; depreciate
3. C) depreciate; appreciate
4. D) depreciate; depreciate
Answer: C
38
If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent,
then the theory of purchasing power parity predicts that, during 2005, the value of the Canadian
dollar in terms of Mexican pesos will
1. A) rise by 6 percent.
2. B) rise by 2 percent.
3. C) fall by 6 percent.
4. D) fall by 2 percent.
Answer: D
39
Assume that the following are the predicted inflation rates in these countries for the year: 2% for
the United States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the purchasing
power parity and everything else held constant, which of the following would we expect to
happen?
1. A) The Brazilian real will depreciate against the U.S. dollar.
2. B) The Mexican peso will depreciate against the Brazilian real.
3. C) The Canadian dollar will depreciate against the Mexican peso.
4. D) The U.S. dollar will depreciate against the Canadian dollar.
Answer: A
40
According to the purchasing power parity theory, a rise in the United States price level of 5
percent, and a rise in the Mexican price level of 6 percent cause
1. A) the dollar to appreciate 1 percent relative to the peso.
2. B) the dollar to depreciate 1 percent relative to the peso.
3. C) the dollar to depreciate 5 percent relative to the peso.
4. D) the dollar to appreciate 5 percent relative to the peso.
Answer: A
41
Higher tariffs and quotas cause a country's currency to ________ in the ________ run, everything
else held constant.
1. A) depreciate; short
2. B) appreciate; short
3. C) depreciate; long
4. D) appreciate; long
Answer: D
42
Lower tariffs and quotas cause a country's currency to ________ in the ________ run, everything
else held constant.
1. A) depreciate; short
2. B) appreciate; short
3. C) depreciate; long
4. D) appreciate; long
Answer: C
43
Anything that increases the demand for foreign goods relative to domestic goods tends to
________ the domestic currency because domestic goods will only continue to sell well if the
value of the domestic currency is ________, everything else held constant.
1. A) depreciate; lower
2. B) depreciate; higher
3. C) appreciate; lower
4. D) appreciate; higher
Answer: A
44
Everything else held constant, increased demand for a country's ________ causes its currency to
appreciate in the long run, while increased demand for ________ causes its currency to depreciate.
1. A) imports; imports
2. B) imports; exports
3. C) exports; imports
4. D) exports; exports
Answer: C
45
Everything else held constant, increased demand for a country's exports causes its currency to
________ in the long run, while increased demand for imports causes its currency to ________.
1. A) appreciate; appreciate
2. B) appreciate; depreciate
3. C) depreciate; appreciate
4. D) depreciate; depreciate
Answer: B
46
Everything else held constant, if a factor increases the demand for ________ goods relative to
________ goods, the domestic currency will appreciate.
1. A) foreign; domestic
2. B) foreign; foreign
3. C) domestic; domestic
4. D) domestic; foreign
Answer: D
47
Everything else held constant, if a factor decreases the demand for ________ goods relative to
________ goods, the domestic currency will depreciate.
1. A) foreign; domestic
2. B) foreign; foreign
3. C) domestic; domestic
4. D) domestic; foreign
Answer: D
48
An increase in productivity in a country will cause its currency to ________ because it can produce
goods at a ________ price, everything else held constant.
1. A) depreciate; lower
2. B) appreciate; lower
3. C) depreciate; higher
4. D) appreciate; higher
Answer: B
49
If, in retaliation for "unfair" trade practices, Congress imposes a 30 percent tariff on Japanese
DVD recorders, but at the same time, U.S. demand for Japanese goods increases, then, in the
long run, ________, everything else held constant.
1. A) the Japanese yen should appreciate relative to the U.S. dollar
2. B) the Japanese yen should depreciate relative to the U.S. dollar
3. C) there is no effect on the Japanese yen relative to the U.S. dollar
4. D) the Japanese yen could appreciate, depreciate or remain constant relative to the
U.S. dollar
Answer: D
50
If the U.S. Congress imposes a quota on imports of Japanese cars due to claims of "unfair" trade
practices, and Japanese demand for American exports increases at the same time, then, in the
long run ________, everything else held constant.
1. A) the Japanese yen will appreciate relative to the U.S. dollar
2. B) the Japanese yen will depreciate relative to the U.S. dollar
3. C) the Japanese yen will either appreciate, depreciate or remain constant against
the U.S. dollar
4. D) there will be no effect on the Japanese yen relative to the U.S. dollar
Answer: B
51
If the inflation rate in the United States is higher than that in Mexico and productivity is growing
at a slower rate in the United States than in Mexico, then, in the long run, ________, everything
else held constant.
1. A) the Mexican peso will appreciate relative to the U.S. dollar
2. B) the Mexican peso will depreciate relative to the U.S. dollar
3. C) the Mexican peso will either appreciate, depreciate, or remain constant relative
to the U.S. dollar
4. D) there will be no effect on the Mexican peso relative to the U.S. dollar
Answer: A
52
If the Brazilian demand for American exports rises at the same time that U.S. productivity rises
relative to Brazilian productivity, then, in the long run, ________, everything else held constant.
1. A) the Brazilian real will appreciate relative to the U.S. dollar
2. B) the Brazilian real will depreciate relative to the U.S. dollar
3. C) the Brazilian real will either appreciate, depreciate, or remain constant relative to
the U.S. dollar
4. D) there is no effect on the Brazilian real relative to the U.S. dollar
Answer: B
53
Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing
power parity explain all exchange rate movements in the short run? What factors determine
long-run exchange rates?
Answer: With no trade barriers and low transport costs, the law of one price states that the price
of traded goods should be the same in all countries. The purchasing power parity theory
extends the law of one price to total economies. PPP states that exchange rates should adjust to
reflect changes in the price levels between two countries. PPP may fail to fully explain exchange
rates because goods are not identical, and price levels include traded and nontraded goods and
services. Long-run exchange rates are determined by domestic price levels relative to foreign
price levels, trade barriers, import and export demand, and productivity.
54
The theory of portfolio choice suggests that the most important factor affecting the demand for
domestic and foreign assets is
1. A) the level of trade and capital flows.
2. B) the expected return on these assets relative to one another.
3. C) the liquidity of these assets relative to one another.
4. D) the riskiness of these assets relative to one another.
Answer: B
55
The ________ suggests that the most important factor affecting the demand for domestic and
foreign assets is the expected return on domestic assets relative to foreign assets.
1. A) theory of portfolio choice
2. B) law of one price
3. C) interest parity condition
4. D) theory of foreign capital mobility
Answer: A
56
The theory of portfolio choice suggests that the most important factor affecting the demand for
domestic and foreign assets is the ________ on these assets relative to one another.
1. A) interest rate
2. B) risk
3. C) expected return
4. D) liquidity
Answer: C
57
As the relative expected return on dollar assets increases, foreigners will want to hold more
________ assets and less ________ assets, everything else held constant.
1. A) foreign; foreign
2. B) foreign; dollar
3. C) dollar; foreign
4. D) dollar; dollar
Answer: C
58
When Americans or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a higher demand for dollar assets and a correspondingly lower
demand for foreign assets.
1. A) dollar; dollar
2. B) dollar; foreign
3. C) foreign; dollar
4. D) foreign; foreign
Answer: B
59
When Americans or foreigners expect the return on dollar assets to be high relative to the return
on foreign assets, there is a ________ demand for dollar assets and a correspondingly ________
demand for foreign assets.
1. A) higher; higher
2. B) higher; lower
3. C) lower; higher
4. D) lower; lower
Answer: B
60
Everything else held constant, when the current value of the domestic currency increases, the
________ domestic assets ________.
1. A) demand for; increases
2. B) quantity demanded of; increases
3. C) demand for; decreases
4. D) quantity demanded of; decreases
Answer: D
61
Everything else held constant, when the current value of the domestic exchange rate increases,
the ________ of domestic assets ________.
1. A) quantity supplied; does not change
2. B) supply; decreases
3. C) quantity supplied; increases
4. D) supply; increases
Answer: A
62
An increase in the domestic interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: A
63
An increase in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: A
64
A decrease in the domestic interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: D
65
A decrease in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: D
66
________ in the domestic interest rate causes the demand for domestic assets to increase and the
domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: A
67
________ in the domestic interest rate causes the demand for domestic assets to shift to the right
and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: A
68
________ in the domestic interest rate causes the demand for domestic assets to decrease and the
domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: D
69
________ in the domestic interest rate causes the demand for domestic assets to shift to the left
and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: D
70
________ in the domestic interest rate causes the demand for domestic assets to ________ and the
domestic currency to appreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: A
71
________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: A
72
________ in the domestic interest rate causes the demand for domestic assets to ________ and the
domestic currency to depreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: D
73
________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to depreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: D
74
Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant, this
will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.
1. A) increase; appreciate
2. B) decrease; appreciate
3. C) increase; depreciate
4. D) decrease; depreciate
Answer: D
75
Suppose that the Federal Reserve conducts an open market sale. Everything else held constant,
this will cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: A
76
An increase in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: D
77
An increase in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: D
78
A decrease in the foreign interest rate causes the demand for domestic assets to ________ and
the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: A
79
A decrease in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: A
80
________ in the foreign interest rate causes the demand for domestic assets to increase and the
domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: C
81
________ in the foreign interest rate causes the demand for domestic assets to shift to the right
and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: C
82
________ in the foreign interest rate causes the demand for domestic assets to decrease and the
domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: B
83
________ in the foreign interest rate causes the demand for domestic assets to shift to the left and
the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: B
84
________ in the foreign interest rate causes the demand for domestic assets to ________ and the
domestic currency to appreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: C
85
________ in the foreign interest rate causes the demand for domestic assets to shift to the ________
and the domestic currency to appreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: C
86
________ in the foreign interest rate causes the demand for domestic assets to ________ and the
domestic currency to depreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: B
87
________ in the foreign interest rate causes the demand for domestic assets to shift to the ________
and the domestic currency to depreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: B
88
Suppose that the European Central Bank enacts expansionary policy. Everything else held
constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.
1. A) increase; appreciate
2. B) decrease; appreciate
3. C) increase; depreciate
4. D) decrease; depreciate
Answer: A
89
Suppose that the European Central Bank conducts a main refinancing sale. Everything else held
constant, this would cause the demand for U.S. assets to ________ and the U.S. dollar will ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: D
90
An increase in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: A
91
An increase in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: A
92
A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: D
93
A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
1. A) right; appreciate
2. B) right; depreciate
3. C) left; appreciate
4. D) left; depreciate
Answer: D
94
________ in the expected future domestic exchange rate causes the demand for domestic assets
to increase and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: A
95
________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the right and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: A
96
________ in the expected future domestic exchange rate causes the demand for domestic assets
to decrease and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: D
97
________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the left and the domestic currency to ________, everything else held constant.
1. A) An increase; appreciate
2. B) An increase; depreciate
3. C) A decrease; appreciate
4. D) A decrease; depreciate
Answer: D
98
________ in the expected future domestic exchange rate causes the demand for domestic assets
to ________ and the domestic currency to appreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: A
99
________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the ________ and the domestic currency to appreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: A
100
________ in the expected future domestic exchange rate causes the demand for domestic assets
to ________ and the domestic currency to depreciate, everything else held constant.
1. A) An increase; increase
2. B) An increase; decrease
3. C) A decrease; increase
4. D) A decrease; decrease
Answer: D
101
________ in the expected future domestic exchange rate causes the demand for domestic assets
to shift to the ________ and the domestic currency to depreciate, everything else held constant.
1. A) An increase; right
2. B) An increase; left
3. C) A decrease; right
4. D) A decrease; left
Answer: D
102
Suppose the Federal Reserve releases a policy statement today which leads people to believe
that the Fed will be enacting expansionary monetary policy in the near future. Everything else
held constant, the release of this statement would immediately cause the demand for U.S. assets
to ________ and the U.S. dollar to ________.
1. A) increase; appreciate
2. B) decrease; appreciate
3. C) increase; depreciate
4. D) decrease; depreciate
Answer: D
103
Suppose a report was released today that showed the Euro-Zone inflation rate is running above
the European Central Bank's inflation rate target. This leads people to expect that the European
Central Bank will enact contractionary policy in the near future. Everything else held constant,
the release of this report would immediately cause the demand for U.S. assets to ________ and
the U.S. dollar will ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: A
104
Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the
U.S. than was expected. Everything else held constant, the release of the CPI report would
immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: D
105
Evidence from the United States during the period 1973-2002 indicates that the value of the
dollar and the measure of the ________ interest rate rose and fell together.
1. A) real
2. B) nominal
3. C) expected
4. D) actual
Answer: A
106
During the beginning on the global financial crisis in the United States when the effects of the
crisis were mostly confined within the United States, the U. S. dollar ________ because demand for
U.S. assets ________.
1. A) appreciated; increased
2. B) depreciated; increased
3. C) appreciated; decreased
4. D) depreciated; decreased
Answer: D
107
When the effects of the global financial crisis started to spread more quickly throughout the rest
of the world, the U.S. dollar ________ because demand for U.S. assets ________.
1. A) appreciated; increased
2. B) depreciated; increased
3. C) appreciated; decreased
4. D) depreciated; decreased
Answer: A
108
Explain and show graphically the effect of an increase in the expected future exchange rate on
the equilibrium exchange rate, everything else held constant.
Answer: See figure Chapter 17 Number 108.
When the expected future exchange rate increases, the relative expected return on the domestic
assets increases. This will cause the demand for domestic assets to increase and the current
value of the exchange rate will appreciate.
109
Explain and show graphically the effect of an increase in the expected inflation rate on the
equilibrium exchange rate, everything else held constant.
Answer: See figure Chapter 17 Number 109
When the expected inflation rate increases, the relative expected return on domestic assets is
affected two ways. First, through the Fisher effect, the domestic nominal interest rate will
increase the expected return on domestic assets. Second, through purchasing power parity, the
future value of the domestic exchange rate will decline which will decrease the expected return
on domestic assets. Since it is generally believed that the effect of the change in the expected
future value of the domestic exchange rate is larger than the Fisher effect, the net effect is a
lower expected return on domestic assets. This will decrease the demand for domestic assets,
which will cause the current value of the domestic exchange rate to depreciate.
110
The condition that states that the domestic interest rate equals the foreign interest rate minus
the expected appreciation of the domestic currency is called
1. A) the purchasing power parity condition.
2. B) the interest parity condition.
3. C) money neutrality.
4. D) the theory of foreign capital mobility.
Answer: B
111
If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, for Francois
the Frenchman the expected rate of return on dollar-denominated assets is
1. A) 11 percent.
2. B) 9 percent.
3. C) 5 percent.
4. D) 3 percent.
5. E) 1 percent.
Answer: B
112
If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected
return on ________-denominated assets in ________ percent.
1. A) dollar; euros is 3
2. B) euro; dollars is 1
3. C) dollar; euros is 1
4. D) euro; dollars is 3
Answer: D
113
If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected
return on ________-denominated assets in terms of ________ percent.
1. A) dollar; euros is 3
2. B) euro; dollars is 1
3. C) dollar; euros is 9
4. D) euro; dollars is 11
Answer: C
114
If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollardenominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected
return on ________-denominated assets in terms of ________ percent.
1. A) dollar; dollars is 7
2. B) euro; dollars is 1
3. C) dollar; euros is 1
4. D) euro; euros is 7
Answer: D
115
If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on pesodenominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Manuel the
Mexican the expected rate of return on euro-denominated assets is
1. A) 11 percent.
2. B) 13 percent.
3. C) 17 percent.
4. D) 19 percent.
Answer: C
116
If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on pesodenominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Francois
the Frenchman the expected rate of return on peso-denominated assets is
1. A) 11 percent.
2. B) 15 percent.
3. C) 17 percent.
4. D) 19 percent.
Answer: A
117
With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the foreign currency is
1. A) 3 percent.
2. B) 10 percent.
3. C) 13.5 percent.
4. D) 17 percent.
Answer: D
118
With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the dollar is
1. A) 3 percent.
2. B) 10 percent.
3. C) 13.5 percent.
4. D) 17 percent.
Answer: B
119
The expected return on dollar deposits in terms of foreign currency can be written as the
________ of the interest rate on dollar deposits and the expected appreciation of the dollar.
1. A) product
2. B) ratio
3. C) sum
4. D) difference
Answer: C
120
In a world with few impediments to capital mobility, the domestic interest rate equals the sum of
the foreign interest rate and the expected depreciation of the domestic currency, a situation
known as the
1. A) interest parity condition.
2. B) purchasing power parity condition.
3. C) exchange rate parity condition.
4. D) foreign asset parity condition.
Answer: A
121
According to the interest parity condition, if the domestic interest rate is 12 percent and the
foreign interest rate is 10 percent, then the expected ________ of the foreign currency must be
________ percent.
1. A) appreciation; 4
2. B) appreciation; 2
3. C) depreciation; 2
4. D) depreciation; 4
Answer: B
122
According to the interest parity condition, if the domestic interest rate is 10 percent and the
foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be
________ percent.
1. A) appreciation; 4
2. B) appreciation; 2
3. C) depreciation; 2
4. D) depreciation; 4
Answer: C
Chapter 18 The International Financial System
18.1 Intervention in the Foreign Exchange Market
1) A central bank ________ of domestic currency and corresponding ________ of foreign assets
in the foreign exchange market leads to an equal decline in its international reserves and the
monetary base, everything else held constant.
A) sale; purchase
B) sale; sale
C) purchase; sale
D) purchase; purchase
Answer: C
Ques Status: Previous Edition
2) A central bank ________ of domestic currency and corresponding ________ of foreign assets
in the foreign exchange market leads to an equal increase in its international reserves and the
monetary base, everything else held constant.
A) sale; purchase
B) sale; sale
C) purchase; sale
D) purchase; purchase
Answer: A
Ques Status: Previous Edition
3) Suppose that the Bank of Japan buys U.S. dollar assets with yen-denominated assets.
Everything else held constant, this transaction will cause ________ in the foreign assets held by
the Federal Reserve and ________ in the U.S. monetary base.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: A
Ques Status: Previous Edition
4) Suppose that the Bank of Japan buys yen-denominated assets with U.S. dollar assets.
Everything else held constant, this transaction will cause ________ in the foreign assets held by
the Federal Reserve and ________ in the U.S. monetary base.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: D
Ques Status: Previous Edition
5) When the central bank allows the purchase or sale of domestic currency to have an effect on
the monetary base, it is called
A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money neutral foreign exchange intervention.
Answer: A
Ques Status: Previous Edition
6) A foreign exchange intervention with an offsetting open market operation that leaves the
monetary base unchanged is called
A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money neutral foreign exchange intervention.
Answer: B
Ques Status: Previous Edition
7) Everything else held constant, if a central bank makes an unsterilized purchase of foreign
assets, then the domestic money supply will ________ and the domestic currency will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: B
Ques Status: Previous Edition
8) Everything else held constant, if a central bank makes an unsterilized ________ of foreign
assets, then the domestic money supply will increase and the domestic currency will ________.
A) purchase; appreciate
B) purchase; depreciate
C) sale; appreciate
D) sale; depreciate
Answer: B
Ques Status: Previous Edition
9) Everything else held constant, if a central bank makes an unsterilized ________ of foreign
assets, then the domestic money supply will ________ and the domestic currency will
appreciate.
A) purchase; increase
B) purchase; decrease
C) sale; increase
D) sale; decrease
Answer: D
Ques Status: Previous Edition
10) Everything else held constant, if a central bank makes an unsterilized sale of foreign assets,
then the domestic money supply will ________ and the domestic currency will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: C
Ques Status: Previous Edition
11) Everything else held constant, if a central bank makes an unsterilized ________ of foreign
assets, then the domestic money supply will decrease and the domestic currency will ________.
A) purchase; appreciate
B) purchase; depreciate
C) sale; appreciate
D) sale; depreciate
Answer: C
Ques Status: Previous Edition
12) Everything else held constant, if a central bank makes an unsterilized ________ of foreign
assets, then the domestic money supply will ________ and the domestic currency will
depreciate.
A) purchase; increase
B) purchase; decrease
C) sale; increase
D) sale; decrease
Answer: A
Ques Status: Previous Edition
13) Everything else held constant, if a central bank makes a sterilized purchase of foreign assets,
then the domestic currency will ________.
A) appreciate
B) depreciate
C) either appreciate, depreciate, or remain constant
D) not be affected
Answer: D
Ques Status: Revised
14) Because sterilized interventions mean offsetting open market operations, there is no impact
on the monetary base and the money supply, and therefore a sterilized intervention
A) causes the exchange rate to overshoot in the short run.
B) causes the exchange rate to undershoot in the short run.
C) causes the exchange rate to depreciate in the short run, but has no effect on the exchange rate
in the long run.
D) has no effect on the exchange rate.
Answer: D
Ques Status: Previous Edition
15) Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then
the domestic currency will ________.
A) appreciate
B) depreciate
C) either appreciate, depreciate, or remain constant
D) not be affected
Answer: D
Ques Status: Previous Edition
16) If the United States has a current account deficit with England of $1 million, and the Bank of
England sells $1 million worth of pounds in the foreign exchange market, then England
________ $1 million of international reserves and its monetary base ________ by $1 million.
A) gains; rises
B) gains; falls
C) loses; rises
D) loses; falls
Answer: A
Ques Status: Previous Edition
17) Explain and demonstrate graphically how an unsterilized purchase of foreign assets leads to
overshooting of the exchange rate, and describe the long-run behavior of the exchange rate,
everything else held constant.
Answer: See figure below
18.2 Balance of Payments
1) The difference between merchandise exports and imports is called the ________ balance.
A) current account
B) capital account
C) official reserve transactions
D) trade
Answer: D
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2) The account that shows international transactions involving currently produced goods and
services is called the
A) trade balance.
B) current account.
C) balance of payments.
D) capital account.
Answer: B
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3) The account that shows international transactions involving financial transactions (stocks,
bonds, bank loans, etc.) is called the
A) trade balance.
B) current account.
C) balance of payments.
D) capital account.
Answer: D
Ques Status: Previous Edition
4) Which of the following does not appear in the current account part of the balance of
payments?
A) A loan of $1 million from Bank of America to Brazil.
B) Foreign aid to El Salvador.
C) An Air France ticket bought by an American.
D) Income earned by General Motors from its plants abroad.
Answer: A
Ques Status: Revised
5) Of the following, the one that appears in the current account of the balance of payments is
A) an Italian investor's purchase of IBM stock.
B) income earned by U.S. subsidiaries of Barclay's Bank of London.
C) a loan by a Swiss bank to an American corporation.
D) a purchase of a British Treasury bond by the Fed.
Answer: B
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6) Capital ________ are American purchases of foreign assets, and capital ________ are foreign
purchases of American assets.
A) inflows; outflows
B) inflows; inflows
C) outflows; outflows
D) outflows; inflows
Answer: D
Ques Status: Previous Edition
7) Which of the following appears in the capital account part of the balance of payments?
A) A gift to an American from his English aunt.
B) A purchase by the Honda corporation of a U.S. Treasury bill.
C) A purchase by the Bank of England of a U.S. Treasury bill.
D) Income earned by the Honda corporation on its automobile plant in Ohio.
Answer: B
Ques Status: Previous Edition
8) The net amount of international reserves that move between governments to finance
international transactions is called the ________ balance.
A) capital account
B) current account
C) trade
D) official reserve transactions
Answer: D
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9) If the current account balance shows a surplus, and the capital account also shows a surplus,
then the official reserve transactions balance
A) must be positive.
B) must be negative.
C) must be zero.
D) can either be positive, negative, or zero.
Answer: A
Ques Status: Revised
10) A current account surplus indicates that America is ________ its claims on foreign wealth,
while a deficit indicates that this country is ________ its claims on foreign wealth.
A) reducing; reducing
B) reducing; increasing
C) increasing; reducing
D) increasing; increasing
Answer: C
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11) Because it provides some indication of what is happening to U.S. claims on foreign wealth
and the demand for imports and exports, the ________ is closely followed by economists
wanting information on the future movement of exchange rates.
A) trade balance
B) capital account
C) current account balance
D) statistical discrepancy
Answer: C
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12) Economists closely follow the current account balance because they believe it can provide
information on the future movement of
A) interest rates.
B) gold flows.
C) exchange rates.
D) special drawing rights.
Answer: C
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18.3 Exchange Rate REgimes in the International Financial System
1) Under a gold standard in which one dollar could be turned in to the U.S. Treasury and
exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th
of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a flow of
gold from the United States to Germany.
A) 7
B) 6
C) 5
D) 4
Answer: D
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2) When gold production was low in the 1870s and 1880s, the money supply grew ________
causing ________.
A) rapidly; inflation
B) rapidly; disinflation
C) slowly; deflation
D) slowly; disinflation
Answer: C
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3) The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been
known as the
A) General Agreement on Tariffs and Trade.
B) Bretton Woods system.
C) International Settlement Fund.
D) Balance of Payments Compliance Accord.
Answer: B
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4) Under the Bretton Woods system, the organization assigned the task of making loans to
countries that were experiencing balance of payments difficulties is known as the
A) World Bank.
B) International Development Association.
C) International Monetary Fund.
D) Federal Reserve System.
Answer: C
Ques Status: Previous Edition
5) The Bretton Woods agreement created the ________, which was given the task of promoting
the growth of world trade by setting rules for the maintenance of fixed exchange rates and by
making loans to countries that were experiencing balance of payments difficulties.
A) IMF
B) World Bank
C) Central Settlements Bank
D) Bank of International Settlements
Answer: A
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6) The World Bank is an international organization that:
A) promotes the growth of trade by setting rules for how tariffs and quotas are set by countries.
B) makes loans to countries to finance projects such as dams and roads.
C) makes loans to countries with balance of payment difficulties.
D) helps developing countries that have been having difficulties in repaying their loans to come
to terms with lenders in the West.
Answer: B
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7) Under the Bretton Woods system, the United States was designated as the
A) reserve-currency country.
B) fixed-rate country.
C) par-standard country.
D) dollar-standard country.
Answer: A
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8) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is,
________ par, the central bank must intervene to sell the domestic currency by purchasing
foreign assets.
A) overvalued; below
B) overvalued; above
C) undervalued; below
D) undervalued; above
Answer: D
Ques Status: Previous Edition
9) Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is,
above par, the central bank must intervene to sell the ________ currency by purchasing
________ assets.
A) domestic; foreign
B) domestic; domestic
C) foreign; foreign
D) foreign; domestic
Answer: A
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10) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is,
________ par, the central bank must intervene to purchase the domestic currency by selling
foreign assets.
A) overvalued; below
B) overvalued; above
C) undervalued; below
D) undervalued; above
Answer: A
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11) Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is,
below par, the central bank must intervene to purchase the ________ currency by selling
________ assets.
A) domestic; foreign
B) domestic; domestic
C) foreign; foreign
D) foreign; domestic
Answer: A
Ques Status: Previous Edition
12) Under a fixed exchange rate regime, if a central bank must intervene to purchase the
________ currency by selling ________ assets, then, like an open market sale, this action
reduces the monetary base and the money supply, causing the interest rate on domestic assets to
rise.
A) domestic; foreign
B) domestic; domestic
C) foreign; foreign
D) foreign; domestic
Answer: A
Ques Status: Previous Edition
13) Under a fixed exchange rate regime, if a central bank must intervene to purchase the
domestic currency by selling foreign assets, then, like an open market sale, this action ________
the monetary base and the money supply, causing the interest rate on domestic assets to
________.
A) increases; rise
B) increases; fall
C) reduces; rise
D) reduces; fall
Answer: C
Ques Status: Previous Edition
14) When the domestic currency is initially overvalued in a fixed exchange rate regime, the
central bank must intervene in the foreign exchange market to ________ the domestic currency,
thereby allowing the money supply to ________.
A) purchase; decline
B) sell; decline
C) purchase; increase
D) sell; increase
Answer: A
Ques Status: Previous Edition
15) When the domestic currency is initially undervalued in a fixed exchange rate regime, the
central bank must intervene in the foreign exchange market to ________ the domestic currency,
thereby allowing the money supply to ________.
A) purchase; decline
B) sell; decline
C) purchase; increase
D) sell; increase
Answer: D
Ques Status: Previous Edition
16) Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its
central bank's attempt to keep its currency from ________ will result in a ________ of
international reserves.
A) depreciating; gain
B) depreciating; loss
C) appreciating; gain
D) appreciating; loss
Answer: B
Ques Status: Previous Edition
17) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its
central bank's attempt to keep its currency from depreciating will result in a ________ of
international reserves.
A) undervalued; gain
B) undervalued; loss
C) overvalued; gain
D) overvalued; loss
Answer: D
Ques Status: Previous Edition
18) Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its
central bank's attempt to keep its currency from ________ will result in a ________ of
international reserves.
A) depreciating; gain
B) depreciating; loss
C) appreciating; gain
D) appreciating; loss
Answer: C
Ques Status: Previous Edition
19) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its
central bank's attempt to keep its currency from appreciating will result in a ________ of
international reserves.
A) undervalued; gain
B) undervalued; loss
C) overvalued; gain
D) overvalued; loss
Answer: A
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20) Under a fixed exchange rate regime, if a country's central bank runs out of international
reserves, it cannot keep its currency from
A) depreciating.
B) appreciating.
C) deflating.
D) inflating.
Answer: A
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21) Under a fixed exchange rate regime, a country that depletes its international reserves in an
attempt to keep its currency from ________ will be forced to ________ its currency.
A) depreciating; revalue
B) depreciating; devalue
C) appreciating; revalue
D) appreciating; devalue
Answer: B
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22) Under a fixed exchange rate regime, a central bank that does not want to acquire
international reserves to keep its currency from ________ will decide to ________ its currency.
A) depreciating; revalue
B) depreciating; devalue
C) appreciating; revalue
D) appreciating; devalue
Answer: C
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23) Under a fixed exchange rate system, countries that ran large, persistent balance of payments
deficits would ________ international reserves, thereby pressuring them into ________ their
exchange rate.
A) gain; devaluing
B) gain; revaluing
C) lose; devaluing
D) lose; revaluing
Answer: C
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24) Under a fixed exchange rate system, countries that ran large, persistent balance of payments
surpluses would ________ international reserves, thereby pressuring them into ________ their
exchange rate.
A) gain; devaluing
B) gain; revaluing
C) lose; devaluing
D) lose; revaluing
Answer: B
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25) A balance of payments ________ is associated with a loss of international reserves, while a
balance of payments ________ is associated with a gain.
A) surplus; surplus
B) surplus; deficit
C) deficit; surplus
D) deficit; deficit
Answer: C
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26) A balance of payments deficit is associated with a ________ of international reserves, while
a balance of payments surplus is associated with a ________.
A) loss; loss
B) loss; gain
C) gain; loss
D) gain; gain
Answer: B
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27) To keep from running out of international reserves under the Bretton Woods system, a
country had to implement ________ monetary policy to ________ its currency.
A) expansionary; strengthen
B) expansionary; weaken
C) contractionary; strengthen
D) contractionary; weaken
Answer: C
Ques Status: Previous Edition
28) Under the Bretton Woods system, when a country adopted an expansionary monetary policy,
thereby causing a balance of payments ________, the country would eventually be forced to
implement ________ monetary policy.
A) deficit; expansionary
B) deficit; contractionary
C) surplus; expansionary
D) surplus; contractionary
Answer: B
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29) Because the United States was the reserve-currency country under the Bretton Woods
system, it could run large balance of payments ________ without ________ significant amounts
of international reserves.
A) deficits; losing
B) deficits; gaining
C) surpluses; losing
D) surpluses; gaining
Answer: A
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30) The Bretton Woods system was one in which central banks
A) bought and sold their own currencies to keep their exchange rates fixed.
B) agreed not to intervene in the foreign exchange market to maintain a fixed exchange rate
regime that had existed prior to World War I.
C) agreed to limit domestic money growth to the average of the five largest industrial nations.
D) agreed to limit domestic money growth to the average of the seven largest industrial nations.
Answer: A
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31) The Bretton Woods system broke down in the early 1970s for all but one of the following
reasons:
A) deficit countries losing international reserves were not willing to devalue their currencies.
B) surplus countries were not willing to revalue their currencies upwards.
C) surplus countries were not willing to pursue more expansionary policies.
D) the United States had been pursuing an inflationary monetary policy to reduce domestic
unemployment.
Answer: A
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32) To maintain fixed exchange rates when countries had balance of payments deficits and were
losing international reserves, the ________ would loan ________ countries international reserves
contributed by other members.
A) IMF; deficit
B) IMF; surplus
C) World Bank; deficit
D) World Bank; surplus
Answer: A
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33) Under the Bretton Woods system, the IMF could encourage ________ countries to pursue
________ monetary policies that would strengthen their currency or eliminate their balance of
payment deficits.
A) surplus; expansionary
B) surplus; contractionary
C) deficit; expansionary
D) deficit; contractionary
Answer: D
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34) Under the Bretton Woods system, the IMF could encourage deficit countries to pursue
contractionary monetary policies that would ________ their currency or eliminate their balance
of payment ________.
A) strengthen; surpluses
B) strengthen; deficits
C) weaken; surpluses
D) weaken; deficits
Answer: B
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35) A weakness of the Bretton Woods system was that the ________ had no way to force surplus
countries to either revalue their exchange rates upwards or pursue more expansionary policies.
A) IMF
B) World Bank
C) European Exchange Rate Mechanism (ERM)
D) Bank of International Settlements
Answer: A
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36) Under the Bretton Woods system, a country running a balance of payments deficit ________
international reserves, and had to implement ________ monetary policy to strengthen its
currency.
A) lost; expansionary
B) lost; contractionary
C) gained; expansionary
D) gained; contractionary
Answer: B
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37) Under the Bretton Woods system, a country running a balance of payments ________ lost
international reserves, and had to implement ________ monetary policy to strengthen its
currency.
A) surplus; expansionary
B) surplus; contractionary
C) deficit; expansionary
D) deficit; contractionary
Answer: D
Ques Status: Previous Edition
38) Under the Bretton Woods system, a country running a balance of payments surplus ________
international reserves, and had to implement ________ monetary policy to weaken its currency.
A) lost; expansionary
B) lost; contractionary
C) gained; expansionary
D) gained; contractionary
Answer: C
Ques Status: Previous Edition
39) Under the Bretton Woods system, if IMF loans were insufficient to prevent ________ of a
currency, then the country was allowed to devalue its currency by setting a new, ________
exchange rate.
A) depreciation; lower
B) depreciation; higher
C) appreciation; lower
D) appreciation; higher
Answer: A
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40) As a result of its power to dictate loan terms to borrowing countries (under the Bretton
Woods system), the IMF could encourage ________ countries to pursue ________ monetary
policies that would strengthen their currency or eliminate their balance of payments deficits.
A) surplus; contractionary
B) surplus; expansionary
C) deficit; contractionary
D) deficit; expansionary
Answer: C
Ques Status: Previous Edition
41) Because central banks have not been willing to give up their option of intervening in the
foreign exchange market, the current international financial system can best be described as a
A) variable-pegged exchange rate system.
B) moving-pegged exchange rate system.
C) hybrid of a fixed exchange rate and flexible exchange rate system.
D) flexible-exchange, dollar-pegged exchange rate system.
Answer: C
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42) The current international financial system is a managed float exchange rate system because
A) exchange rates fluctuate in response to, but are not determined solely by, market forces.
B) some countries keep their currencies pegged to the dollar, which is not allowed to fluctuate.
C) all countries allow their exchange rates to fluctuate in response to market forces.
D) all countries peg their currencies to the dollar which is allowed to fluctuate in response to
market forces.
Answer: A
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43) Policymakers in a country with a balance of payments surplus may not want to see their
country's currency appreciate because this would
A) hurt consumers in their country by making foreign goods more expensive.
B) hurt domestic businesses by making foreign goods cheaper in their country.
C) increase inflation in their country.
D) decrease the wealth of the country.
Answer: B
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44) Under the current managed float exchange rate regime, countries with balance of payments
deficits frequently do not want to see their currencies depreciate because it makes ________
goods more expensive for ________ consumers and can stimulate inflation.
A) foreign; foreign
B) foreign; domestic
C) domestic; foreign
D) domestic; domestic
Answer: B
Ques Status: Previous Edition
45) Countries with surpluses in their balance of payments frequently do not want to see their
currencies ________ because it makes their goods ________ expensive abroad.
A) appreciate; less
B) appreciate; more
C) depreciate; less
D) depreciate; more
Answer: B
Ques Status: Revised
46) Countries with balance of payments deficits do not want to see their currencies ________
because it makes foreign goods ________ expensive for domestic consumers.
A) appreciate; less
B) appreciate; more
C) depreciate; less
D) depreciate; more
Answer: D
Ques Status: Previous Edition
47) Under the current managed float exchange rate regime, countries with ________ in their
balance of payments frequently do not want to see their currencies ________ because it makes
their goods more expensive abroad and foreign goods cheaper in their countries.
A) surpluses; depreciate
B) deficits; depreciate
C) surpluses; appreciate
D) deficits; appreciate
Answer: C
Ques Status: Previous Edition
48) Under the current managed float exchange rate regime; countries with surpluses in their
balance of payments frequently do not want to see their currencies appreciate because it makes
their goods ________ expensive abroad and foreign goods ________ in their countries.
A) more; cheaper
B) more; costlier
C) less; cheaper
D) less; costlier
Answer: A
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49) Under the current managed float exchange rate regime, countries with balance of payments
________ frequently do not want to see their currencies ________ because it makes foreign
goods more expensive for domestic consumers and can stimulate inflation.
A) surpluses; depreciate
B) deficits; depreciate
C) surpluses; appreciate
D) deficits; appreciate
Answer: B
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50) Which of the following is true?
A) Special drawing rights are loans to countries made by the IMF.
B) Changes in the quantity of special drawing rights are tied to changes in the quantity of gold.
C) Special drawing rights are a paper substitute for gold.
D) Special drawing rights are not held as international reserves.
Answer: C
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51) An ECU was
A) a paper substitute for gold issued by the IMF.
B) a loan by European countries to the IMF.
C) a paper currency issued by the European Common Market.
D) a monetary unit created by the European Monetary System.
Answer: D
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52) Under the Exchange Rate Mechanism of the European Monetary System, when the British
pound depreciated below its lower limit against the German mark, the Bank of England was
required to buy ________ and sell ________, thereby ________ international reserves.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
Answer: A
Ques Status: Previous Edition
53) Under the Exchange Rate Mechanism of the European Monetary System, when the British
pound depreciated below its lower limit against the German mark, the German central bank was
required to buy ________ and sell ________, thereby ________ international reserves.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
Answer: B
Ques Status: Previous Edition
54) Under the Exchange Rate Mechanism of the European Monetary System, when the German
mark depreciated below its lower limit against the British pound, the Bank of England was
required to buy ________ and sell ________, thereby ________ international reserves.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
Answer: C
Ques Status: Previous Edition
55) Under the Exchange Rate Mechanism of the European Monetary System, when the German
mark depreciated below its lower limit against the British pound, the German central bank was
required to buy ________ and sell ________, thereby ________ international reserves.
A) pounds; marks; losing
B) pounds; marks; gaining
C) marks; pounds; gaining
D) marks; pounds; losing
Answer: D
Ques Status: Previous Edition
56) In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to
the British pound, but it failed because participants in the foreign exchange market came to
expect the
A) appreciation of the mark.
B) depreciation of the mark.
C) revaluation of the dollar.
D) end of the Exchange Rate Mechanism.
Answer: A
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57) The East Asia currency crisis in 1997 started in
A) Japan.
B) Thailand.
C) South Korea.
D) the Philippines.
Answer: B
Ques Status: Revised
58) Between May and July 1997, concerns about the large current account deficit in Thailand
and the weakness in the Thai financial system caused speculators to suspect that Thailand might
be forced to
A) devalue its currency.
B) sell baht to prop up its value.
C) buy dollars to prop up the baht.
D) impose capital controls.
Answer: A
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59) Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed
exchange rate system. What alternative policies are available to eliminate the overvaluation of
the exchange rate?
Answer: See the figure below.
The par value is above the equilibrium value, resulting in overvaluation of the exchange rate.
One approach is to pursue contractionary monetary policies, raising interest rates and increasing
the demand for domestic assets. This process continues until equilibrium at par value is restored.
Another alternative is for the central bank to purchase domestic currency by selling foreign
assets.
Ques Status: Previous Edition
60) Assume that a fixed exchange rate is overvalued. Describe the situation of a speculative
crisis against this currency. What can the central bank do to defend the currency? Why might the
alternative of devaluation be preferable?
Answer: When the speculative attack begins, the expected depreciation of the domestic currency
increases substantially, decreasing the demand for domestic assets. Contractionary monetary
policy is needed to increase domestic interest rates enough to defend the currency. The cost to
the central bank in terms of the costs of intervention and the contractionary effect on the
economy may make devaluation preferable.
Ques Status: Previous Edition
18.4 Capital Controls
1) A capital ________ can promote financial instability in an emerging-market country because it
is what forces a country to ________ its currency.
A) inflow; devalue
B) inflow; revalue
C) outflow; devalue
D) outflow; revalue
Answer: C
Ques Status: Previous Edition
2) A capital ________ can promote financial instability in an emerging-market country because it
can lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a
________.
A) inflow; financial crisis
B) inflow; currency devaluation
C) outflow; financial crisis
D) outflow; currency devaluation
Answer: A
Ques Status: Previous Edition
3) A case for capital inflow controls can be made because capital inflows
A) can cause a lending boom and lead to excessive risk taking.
B) never finance productive investments.
C) always finance productive investments.
D) are less likely to cause financial crises than regulation of banking activities.
Answer: A
Ques Status: Previous Edition
4) Which of the following is not a disadvantage of controls on capital outflows?
A) The controls may lead to excessive risk taking by the domestic banks.
B) They are seldom effective during a crisis.
C) Capital flight may increase after they are put in place.
D) Controls often lead to an increase in government corruption.
Answer: A
Ques Status: Previous Edition
18.5 The Role of the IMF
1) In the 1990s this agency has acted like an international lender of last resort to cope with
financial instability.
A) World Bank
B) European Central Bank
C) IMF
D) International Bank for Reconstruction and Development
Answer: C
Ques Status: Previous Edition
2) An international lender of last resort creates a serious ________ problem because depositors
and other creditors of banking institutions expect that they will be protected if a crisis occurs.
A) moral hazard
B) adverse selection
C) public choice
D) strategic choice
Answer: A
Ques Status: Previous Edition
3) An international lender of last resort creates a serious moral hazard problem because
________ and other ________ of banking institutions expect that they will be protected if a crisis
occurs.
A) depositors; debtors
B) depositors; creditors
C) borrowers; debtors
D) borrowers; creditors
Answer: B
Ques Status: Previous Edition
4) Critics of the IMF contend that its lending in the Mexican crisis, which was used to bail out
foreign ________, set the stage for the ________ crisis because these ________ expected to be
bailed out if things went wrong.
A) lenders; East Asian; borrowers
B) lenders; East Asian; lenders
C) borrowers; Russian; borrowers
D) borrowers; Russian; lenders
Answer: B
Ques Status: Previous Edition
5) Critics of the IMF contend that its lending in the ________ crisis, which was used to bail out
foreign lenders, set the stage for the ________ crisis because these lenders expected to be bailed
out if things went wrong and thus provided funds that were used to fuel excessive risk taking.
A) Russian; Mexican
B) Russian; East Asian
C) Mexican; Russian
D) Mexican; East Asian
Answer: D
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6) An advantage of an international lender of last resort is its ability to prevent ________, in
which a successful speculative attack on one currency leads to attacks on others; its disadvantage
is the problem of ________ if creditors expect to be protected if a crisis occurs.
A) contagion; moral hazard
B) contagion; adverse selection
C) currency virus; moral hazard
D) currency virus; adverse selection
Answer: A
Ques Status: Previous Edition
7) An advantage of an international lender of last resort is its ability to prevent ________, in
which a successful speculative attack on one currency leads to attacks on others; its disadvantage
is the problem of ________ if creditors expect to be protected if a crisis occurs.
A) contagion; moral hazard
B) contagion; adverse selection
C) currency virus; moral hazard
D) currency virus; adverse selection
Answer: A
Ques Status: Previous Edition
18.6 International Considerations and Monetary Policy
1) In the early 1970s, the U.S. ran large balance of payments ________, causing an ________
dollar and an ________ German mark.
A) deficits; undervalued; overvalued
B) deficits; overvalued; undervalued
C) surpluses; undervalued; overvalued
D) surpluses; overvalued; undervalued
Answer: B
Ques Status: Previous Edition
2) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought
________ and sold ________ to keep the exchange rate fixed, gaining international reserves.
A) marks; dollars
B) marks; pounds
C) dollars; marks
D) dollars; pounds
Answer: C
Ques Status: Previous Edition
3) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought
dollars and sold marks to keep the exchange rate fixed, gaining international reserves. The huge
purchase of international reserves meant that the German monetary base began to ________,
leading to ________ growth in the German money supply.
A) decline; sluggish
B) decline; rapid
C) grow; sluggish
D) grow; rapid
Answer: D
Ques Status: Previous Edition
4) The German central bank gained international reserves in the early 1970s because it sold
________ to prevent mark ________.
A) marks; appreciation
B) dollars; appreciation
C) marks; depreciation
D) dollars; depreciation
Answer: A
Ques Status: Previous Edition
5) Since the abandonment of the Bretton Woods system, balance of payments considerations
have become ________ important, and exchange rate considerations ________ important in the
conduct of monetary policy.
A) more; less
B) more; more
C) less; less
D) less; more
Answer: D
Ques Status: Previous Edition
6) If a central bank does not want to see its currency fall in value, it may pursue ________
monetary policy to ________ the domestic interest rate, thereby strengthening its currency.
A) expansionary; raise
B) contractionary; raise
C) expansionary; lower
D) contractionary; lower
Answer: B
Ques Status: Previous Edition
7) If a central bank does not want to see its currency ________ in value, it may pursue
contractionary monetary policy to raise the domestic interest rate, thereby ________ its currency.
A) fall; strengthening
B) fall; weakening
C) rise; strengthening
D) rise; weakening
Answer: A
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8) If a central bank does not want to see its currency rise in value, it may pursue ________
monetary policy to ________ the domestic interest rate, thereby weakening its currency.
A) expansionary; raise
B) contractionary; raise
C) expansionary; lower
D) contractionary; lower
Answer: C
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9) If a central bank does not want to see its currency ________ in value, it may pursue
expansionary monetary policy to lower the domestic interest rate, thereby ________ its currency.
A) fall; strengthening
B) fall; weakening
C) rise; strengthening
D) rise; weakening
Answer: D
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10) If a central bank does not want to allow the domestic currency to appreciate, it will ________
international reserves by selling its currency, thereby ________ the monetary base and increasing
the risk of higher inflation.
A) lose; decreasing
B) lose; increasing
C) acquire; decreasing
D) acquire; increasing
Answer: D
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11) If a central bank does not want to allow the domestic currency to depreciate, it will ________
international reserves by purchasing its currency, thereby ________ the monetary base and
increasing the risk of higher unemployment.
A) lose; decreasing
B) lose; increasing
C) acquire; decreasing
D) acquire; increasing
Answer: A
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12) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic
inflation if the ________ of its currency leads to ________ international reserves which
________ the monetary base.
A) purchase; higher; increases
B) purchase; lower; decreases
C) sale; lower; decreases
D) sale; higher; increases
Answer: D
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13) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic
inflation if the ________ of foreign currencies leads to ________ international reserves which
________ the monetary base.
A) purchase; higher; increases
B) purchase; lower; decreases
C) sale; lower; decreases
D) sale; higher; increases
Answer: A
Ques Status: Previous Edition
18.7 To Peg or Not To Peg: Exchange-Rate Targeting as an Alternative Monetary Policy
Strategy
1) A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a
currency to the currency of a large, low inflation country is called ________ targeting.
A) exchange-rate
B) currency
C) monetary
D) inflation
Answer: A
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2) Under an exchange-rate targeting rule for monetary policy, a crawling peg
A) fixes the value of the domestic currency to a commodity such as gold.
B) fixes the value of the domestic currency to that of a large, low-inflation country.
C) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging
country can be higher than that of the anchor country.
D) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging
country can be lower than that of the anchor country.
Answer: C
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3) An advantage to exchange-rate targeting is it helps keep inflation under control by tying the
inflation rate for ________ traded goods to what is found in the ________ country.
A) domestically; anchor
B) domestically, domestic
C) internationally; anchor
D) internationally; domestic
Answer: C
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4) Exchange-rate targeting allows a central bank to ________, thus this will ________ the
probability of policy developing a time-inconsistency problem.
A) be governed by a policy rule; decrease
B) follow discretionary policy; decrease
C) be governed by a policy rule; increase
D) follow discretionary policy; increase
Answer: A
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5) Which of the following is not an advantage to exchange-rate targeting?
A) It provides a strong nominal anchor to keep inflation under control.
B) It provides an automatic rule for policy to help avoid the time-inconsistency problem.
C) It is simple and clear so that the public can easily understand it.
D) It increases the accountability of policymakers.
Answer: D
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6) Under exchange-rate targeting, the central bank in the targeting country ________ lose the
ability to pursue its own independent monetary policy and any shocks to the anchor country is
________ transmitted to the targeting country.
A) does; directly
B) does not; directly
C) does; not directly
D) does not; not directly
Answer: A
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7) Both France and the United Kingdom successfully used exchange-rate targeting to lower
inflation in the late 1980s and early 1990s by tying the value of their currencies to the
A) U.S. dollar.
B) German mark.
C) Swiss franc.
D) Euro.
Answer: B
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8) Which of the following is not a disadvantage of exchange-rate targeting?
A) It relies on a stable money-inflation relationship.
B) The targeting country gives up an independent monetary policy.
C) The targeting country is left open for a speculative attack.
D) It can weaken the accountability of policymakers.
Answer: A
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9) Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the
country ________ conduct successful monetary policy on its own, and if the country wants to
________ integration of the domestic economy with its neighbors.
A) cannot; encourage
B) cannot; discourage
C) can; encourage
D) can; discourage
Answer: A
Ques Status: Revised
10) An emerging market country that successfully used exchange-rate targeting to lower its
inflation from above 100 percent in 1988 to below 10 percent in 1994 (before devaluation) was
A) Thailand.
B) Mexico.
C) The Philippines.
D) Indonesia.
Answer: B
Ques Status: Revised
11) Because many emerging market countries have not developed the political or monetary
institutions that allow the successful use of discretionary monetary policy,
A) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or
Germany.
B) they have little to gain from using a nominal anchor, because it would mean a monetary
policy that is overly expansionary.
C) they have very little to gain from an independent monetary policy, but a lot to lose.
D) they would be better off giving their central bankers the independence to use discretion, rather
than take their discretion away through any nominal anchor.
Answer: C
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12) Emerging market countries are in effect between a rock and a hard place because
A) they would be wise to adopt the monetary policy of the United States by pegging their
currencies to the dollar, but this policy leaves them open to speculative attacks.
B) to avoid speculative attacks on their currencies they must peg their exchange rates to an
anchor country, but this means giving central bankers in these countries too much discretion.
C) to avoid speculative attacks on their currencies they must peg their exchange rates to an
anchor country, but this means giving central bankers in these countries too little discretion.
D) by adopting the monetary policy of the anchor country through an exchange rate peg, these
countries allow for too little monetary expansion and thereby sacrifice economic growth for price
stability.
Answer: A
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13) When a domestic currency is completely backed by a foreign currency and the note-issuing
authority establishes a fixed exchange rate to this foreign currency, then the country is said to
have
A) created a currency board.
B) undergone dollarization.
C) adopted a managed exchange system.
D) adopted an exchange rate monetary system.
Answer: A
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14) When a country forgoes its own currency and starts using another country's currency as its
own, we say that this country has
A) created a currency board.
B) undergone dollarization.
C) adopted a managed exchange system.
D) adopted an exchange rate monetary system.
Answer: A
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15) The revenue a government gains from issuing money is
A) interest.
B) rent.
C) seignorage.
D) the national dividend.
E) the inflation tax.
Answer: C
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16) A country that dollarizes
A) maximizes its seignorage.
B) earns the same amount of seignorage as it would with a currency board.
C) earns the same amount of seignorage as it would with exchange-rate targeting.
D) eliminates its seignorage.
E) must pay seignorage to other governments to use their currency.
Answer: D
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17) The seignorage for a government is greater for ________ than for ________.
A) dollarization; a currency board
B) dollarization; exchange-rate targeting
C) dollarization; monetary targeting
D) dollarization; inflation targeting
E) exchange-rate targeting; dollarization
Answer: E
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18) Exchange-rate targeting is not an option for the United States because
A) the United States is already dollarized.
B) the United States is too large.
C) the Fed has adopted a monetary targeting strategy.
D) the Fed has adopted an inflation targeting strategy.
Answer: B
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19) The monetary policy strategy that provides an automatic rule for the conduct of monetary
policy is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
Answer: A
Ques Status: Previous Edition
20) The monetary policy strategy that does not allow the policy to focus on domestic
considerations is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
Answer: A
Ques Status: Previous Edition
21) The monetary policy strategy that results in the loss of an independent monetary policy is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
Answer: A
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22) The monetary policy strategy that directly ties down the price of internationally traded goods
is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
Answer: A
Ques Status: Previous Edition
23) Explain an additional disadvantage for a country undergoing dollarization compared to a
currency board or other exchange-rate targeting regimes.
Answer: The additional disadvantage to dollarization is that the government loses seignorage.
Seignorage is the income that a government earns by issuing its own currency.
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24) Explain the 1992 crisis that led to the breakdown of the European Union's Exchange Rate
Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?
Answer: The 1992 crisis began with Germany raising interest rates in 1990 to stem inflationary
pressures from reunification. This demand shock was immediately transmitted to the other
nations in the exchange-rate mechanism. Thus, these countries did not have independent
monetary policies and were subject to shocks from the anchor country. This gave rise to the
second problem. Speculators bet that these other countries would not want the increased
unemployment resulting from the tight monetary policy. Betting that their commitment was
weak, speculators bet against these currencies, and a number were forced to devalue or drop out
of the ERM. The disadvantages illustrated by this are the lack of independent policy subjecting
member nations to shocks from the anchor nation, and the possibility of speculative attacks when
commitment is felt to be weak.
Ques Status: Previous Edition
1
A central bank ________ of domestic currency and corresponding ________ of foreign assets in the
foreign exchange market leads to an equal decline in its international reserves and the monetary
base, everything else held constant.
1. A) sale; purchase
2. B) sale; sale
3. C) purchase; sale
4. D) purchase; purchase
Answer: C
2
A central bank ________ of domestic currency and corresponding ________ of foreign assets in the
foreign exchange market leads to an equal increase in its international reserves and the
monetary base, everything else held constant.
1. A) sale; purchase
2. B) sale; sale
3. C) purchase; sale
4. D) purchase; purchase
Answer: A
3
Suppose that the Bank of Japan buys U.S. dollar assets with yen-denominated assets. Everything
else held constant, this transaction will cause ________ in the foreign assets held by the Federal
Reserve and ________ in the U.S. monetary base.
1. A) an increase; an increase
2. B) an increase; a decrease
3. C) a decrease; an increase
4. D) a decrease; a decrease
Answer: A
4
Suppose that the Bank of Japan buys yen-denominated assets with U.S. dollar assets. Everything
else held constant, this transaction will cause ________ in the foreign assets held by the Federal
Reserve and ________ in the U.S. monetary base.
1. A) an increase; an increase
2. B) an increase; a decrease
3. C) a decrease; an increase
4. D) a decrease; a decrease
Answer: D
5
When the central bank allows the purchase or sale of domestic currency to have an effect on the
monetary base, it is called
1. A) an unsterilized foreign exchange intervention.
2. B) a sterilized foreign exchange intervention.
3. C) an exchange rate feedback rule.
4. D) a money neutral foreign exchange intervention.
Answer: A
6
A foreign exchange intervention with an offsetting open market operation that leaves the
monetary base unchanged is called
1. A) an unsterilized foreign exchange intervention.
2. B) a sterilized foreign exchange intervention.
3. C) an exchange rate feedback rule.
4. D) a money neutral foreign exchange intervention.
Answer: B
7
Everything else held constant, if a central bank makes an unsterilized purchase of foreign assets,
then the domestic money supply will ________ and the domestic currency will ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: B
8
Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets,
then the domestic money supply will increase and the domestic currency will ________.
1. A) purchase; appreciate
2. B) purchase; depreciate
3. C) sale; appreciate
4. D) sale; depreciate
Answer: B
9
Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets,
then the domestic money supply will ________ and the domestic currency will appreciate.
1. A) purchase; increase
2. B) purchase; decrease
3. C) sale; increase
4. D) sale; decrease
Answer: D
10
Everything else held constant, if a central bank makes an unsterilized sale of foreign assets, then
the domestic money supply will ________ and the domestic currency will ________.
1. A) increase; appreciate
2. B) increase; depreciate
3. C) decrease; appreciate
4. D) decrease; depreciate
Answer: C
11
Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets,
then the domestic money supply will decrease and the domestic currency will ________.
1. A) purchase; appreciate
2. B) purchase; depreciate
3. C) sale; appreciate
4. D) sale; depreciate
Answer: C
12
Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets,
then the domestic money supply will ________ and the domestic currency will depreciate.
1. A) purchase; increase
2. B) purchase; decrease
3. C) sale; increase
4. D) sale; decrease
Answer: A
13
Everything else held constant, if a central bank makes a sterilized purchase of foreign assets,
then the domestic currency will
1. A) appreciate.
2. B) depreciate.
3. C) either appreciate, depreciate, or remain constant.
4. D) not be affected.
Answer: D
14
Because sterilized interventions mean offsetting open market operations, there is no impact on
the monetary base and the money supply, and therefore a sterilized intervention
1. A) causes the exchange rate to overshoot in the short run.
2. B) causes the exchange rate to undershoot in the short run.
3. C) causes the exchange rate to depreciate in the short run, but has no effect on the
exchange rate in the long run.
4. D) has no effect on the exchange rate.
Answer: D
15
Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then the
domestic currency will
1. A) appreciate.
2. B) depreciate.
3. C) either appreciate, depreciate, or remain constant.
4. D) not be affected.
Answer: D
16
If the United States has a current account deficit with England of $1 million, and the Bank of
England sells $1 million worth of pounds in the foreign exchange market, then England ________
$1 million of international reserves and its monetary base ________ by $1 million.
1. A) gains; rises
2. B) gains; falls
3. C) loses; rises
4. D) loses; falls
Answer: A
17
The difference between merchandise exports and imports is called the ________ balance.
1. A) current account
2. B) capital account
3. C) official reserve transactions
4. D) trade
Answer: D
18
The account that shows international transactions involving currently produced goods and
services is called the
1. A) trade balance.
2. B) current account.
3. C) balance of payments.
4. D) capital account.
Answer: B
19
The account that shows international transactions involving financial transactions (stocks, bonds,
bank loans, etc.) is called the
1. A) trade balance.
2. B) current account.
3. C) balance of payments.
4. D) capital account.
Answer: D
20
Which of the following does NOT appear in the current account part of the balance of
payments?
1. A) a loan of $1 million from Bank of America to Brazil
2. B) foreign aid to El Salvador
3. C) an Air France ticket bought by an American
4. D) income earned by General Motors from its plants abroad
Answer: A
21
Of the following, the one that appears in the current account of the balance of payments is
1. A) an Italian investor's purchase of IBM stock.
2. B) income earned by U.S. subsidiaries of Barclay's Bank of London.
3. C) a loan by a Swiss bank to an American corporation.
4. D) a purchase of a British Treasury bond by the Fed.
Answer: B
22
Capital ________ are American purchases of foreign assets, and capital ________ are foreign
purchases of American assets.
1. A) inflows; outflows
2. B) inflows; inflows
3. C) outflows; outflows
4. D) outflows; inflows
Answer: D
23
Which of the following appears in the capital account part of the balance of payments?
1. A) a gift to an American from his English aunt
2. B) a purchase by the Honda corporation of a U.S. Treasury bill
3. C) a purchase by the Bank of England of a U.S. Treasury bill
4. D) income earned by the Honda corporation on its automobile plant in Ohio
Answer: B
24
The net amount of international reserves that move between governments to finance
international transactions is called the ________ balance.
1. A) capital account
2. B) current account
3. C) trade
4. D) official reserve transactions
Answer: D
25
If the current account balance shows a surplus, and the capital account also shows a surplus,
then the official reserve transactions balance
1. A) must be positive.
2. B) must be negative.
3. C) must be zero.
4. D) can either be positive, negative, or zero.
Answer: A
26
A current account surplus indicates that America is ________ its claims on foreign wealth, while a
deficit indicates that this country is ________ its claims on foreign wealth.
1. A) reducing; reducing
2. B) reducing; increasing
3. C) increasing; reducing
4. D) increasing; increasing
Answer: C
27
Because it provides some indication of what is happening to U.S. claims on foreign wealth and
the demand for imports and exports, the ________ is closely followed by economists wanting
information on the future movement of exchange rates.
1. A) trade balance
2. B) capital account
3. C) current account balance
4. D) statistical discrepancy
Answer: C
28
Economists closely follow the current account balance because they believe it can provide
information on the future movement of
1. A) interest rates.
2. B) gold flows.
3. C) exchange rates.
4. D) special drawing rights.
Answer: C
29
Under a gold standard in which one dollar could be turned in to the U.S. Treasury and
exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for
1/100th of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a
flow of gold from the United States to Germany.
1. A) 7
2. B) 6
3. C) 5
4. D) 4
Answer: D
30
When gold production was low in the 1870s and 1880s, the money supply grew ________ causing
________.
1. A) rapidly; inflation
2. B) rapidly; disinflation
3. C) slowly; deflation
4. D) slowly; disinflation
Answer: C
31
The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been
known as the
1. A) General Agreement on Tariffs and Trade.
2. B) Bretton Woods system.
3. C) International Settlement Fund.
4. D) Balance of Payments Compliance Accord.
Answer: B
32
Under the Bretton Woods system, the organization assigned the task of making loans to
countries that were experiencing balance of payments difficulties is known as the
1. A) World Bank.
2. B) International Development Association.
3. C) International Monetary Fund.
4. D) Federal Reserve System.
Answer: C
33
The Bretton Woods agreement created the ________, which was given the task of promoting the
growth of world trade by setting rules for the maintenance of fixed exchange rates and by
making loans to countries that were experiencing balance of payments difficulties.
1. A) IMF
2. B) World Bank
3. C) Central Settlements Bank
4. D) Bank of International Settlements
Answer: A
34
The World Bank is an international organization that
1. A) promotes the growth of trade by setting rules for how tariffs and quotas are set
by countries.
2. B) makes loans to countries to finance projects such as dams and roads.
3. C) makes loans to countries with balance of payment difficulties.
4. D) helps developing countries that have been having difficulties in repaying their
loans to come to terms with lenders in the West.
Answer: B
35
Under the Bretton Woods system, the United States was designated as the
1. A) reserve-currency country.
2. B) fixed-rate country.
3. C) par-standard country.
4. D) dollar-standard country.
Answer: A
36
Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________
par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.
1. A) overvalued; below
2. B) overvalued; above
3. C) undervalued; below
4. D) undervalued; above
Answer: D
37
Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is,
above par, the central bank must intervene to sell the ________ currency by purchasing ________
assets.
1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic
Answer: A
38
Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________
par, the central bank must intervene to purchase the domestic currency by selling foreign assets.
1. A) overvalued; below
2. B) overvalued; above
3. C) undervalued; below
4. D) undervalued; above
Answer: A
39
Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is,
below par, the central bank must intervene to purchase the ________ currency by selling ________
assets.
1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic
Answer: A
40
Under a fixed exchange rate regime, if a central bank must intervene to purchase the ________
currency by selling ________ assets, then, like an open market sale, this action reduces the
monetary base and the money supply, causing the interest rate on domestic assets to rise.
1. A) domestic; foreign
2. B) domestic; domestic
3. C) foreign; foreign
4. D) foreign; domestic
Answer: A
41
Under a fixed exchange rate regime, if a central bank must intervene to purchase the domestic
currency by selling foreign assets, then, like an open market sale, this action ________ the
monetary base and the money supply, causing the interest rate on domestic assets to ________.
1. A) increases; rise
2. B) increases; fall
3. C) reduces; rise
4. D) reduces; fall
Answer: C
42
When the domestic currency is initially overvalued in a fixed exchange rate regime, the central
bank must intervene in the foreign exchange market to ________ the domestic currency, thereby
allowing the money supply to ________.
1. A) purchase; decline
2. B) sell; decline
3. C) purchase; increase
4. D) sell; increase
Answer: A
43
When the domestic currency is initially undervalued in a fixed exchange rate regime, the central
bank must intervene in the foreign exchange market to ________ the domestic currency, thereby
allowing the money supply to ________.
1. A) purchase; decline
2. B) sell; decline
3. C) purchase; increase
4. D) sell; increase
Answer: D
44
Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its
central bank's attempt to keep its currency from ________ will result in a ________ of international
reserves.
1. A) depreciating; gain
2. B) depreciating; loss
3. C) appreciating; gain
4. D) appreciating; loss
Answer: B
45
Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central
bank's attempt to keep its currency from depreciating will result in a ________ of international
reserves.
1. A) undervalued; gain
2. B) undervalued; loss
3. C) overvalued; gain
4. D) overvalued; loss
Answer: D
46
Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its
central bank's attempt to keep its currency from ________ will result in a ________ of international
reserves.
1. A) depreciating; gain
2. B) depreciating; loss
3. C) appreciating; gain
4. D) appreciating; loss
Answer: C
47
Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central
bank's attempt to keep its currency from appreciating will result in a ________ of international
reserves.
1. A) undervalued; gain
2. B) undervalued; loss
3. C) overvalued; gain
4. D) overvalued; loss
Answer: A
48
Under a fixed exchange rate regime, if a country's central bank runs out of international
reserves, it cannot keep its currency from
1. A) depreciating.
2. B) appreciating.
3. C) deflating.
4. D) inflating.
Answer: A
49
Under a fixed exchange rate regime, a country that depletes its international reserves in an
attempt to keep its currency from ________ will be forced to ________ its currency.
1. A) depreciating; revalue
2. B) depreciating; devalue
3. C) appreciating; revalue
4. D) appreciating; devalue
Answer: B
50
Under a fixed exchange rate regime, a central bank that does not want to acquire international
reserves to keep its currency from ________ will decide to ________ its currency.
1. A) depreciating; revalue
2. B) depreciating; devalue
3. C) appreciating; revalue
4. D) appreciating; devalue
Answer: C
51
A balance of payments deficit is associated with a ________ of international reserves, while a
balance of payments surplus is associated with a ________.
1. A) loss; loss
2. B) loss; gain
3. C) gain; loss
4. D) gain; gain
Answer: B
52
Because central banks have not been willing to give up their option of intervening in the foreign
exchange market, the current international financial system can best be described as a
1. A) variable-pegged exchange rate system.
2. B) moving-pegged exchange rate system.
3. C) hybrid of a fixed exchange rate and flexible exchange rate system.
4. D) flexible-exchange, dollar-pegged exchange rate system.
Answer: C
53
The current international financial system is a managed float exchange rate system because
1. A) exchange rates fluctuate in response to, but are not determined solely by,
market forces.
2. B) some countries keep their currencies pegged to the dollar, which is not allowed
to fluctuate.
3. C) all countries allow their exchange rates to fluctuate in response to market forces.
4. D) all countries peg their currencies to the dollar which is allowed to fluctuate in
response to market forces.
Answer: A
54
Policymakers in a country with a balance of payments surplus may not want to see their
country's currency appreciate because this would
1. A) hurt consumers in their country by making foreign goods more expensive.
2. B) hurt domestic businesses by making foreign goods cheaper in their country.
3. C) increase inflation in their country.
4. D) decrease the wealth of the country.
Answer: B
55
Under the current managed float exchange rate regime, countries with balance of payments
deficits frequently do not want to see their currencies depreciate because it makes ________
goods more expensive for ________ consumers and can stimulate inflation.
1. A) foreign; foreign
2. B) foreign; domestic
3. C) domestic; foreign
4. D) domestic; domestic
Answer: B
56
Countries with surpluses in their balance of payments frequently do not want to see their
currencies ________ because it makes their goods ________ expensive abroad.
1. A) appreciate; less
2. B) appreciate; more
3. C) depreciate; less
4. D) depreciate; more
Answer: B
57
Countries with balance of payments deficits do not want to see their currencies ________ because
it makes foreign goods ________ expensive for domestic consumers.
1. A) appreciate; less
2. B) appreciate; more
3. C) depreciate; less
4. D) depreciate; more
Answer: D
58
Under the current managed float exchange rate regime, countries with ________ in their balance
of payments frequently do not want to see their currencies ________ because it makes their
goods more expensive abroad and foreign goods cheaper in their countries.
1. A) surpluses; depreciate
2. B) deficits; depreciate
3. C) surpluses; appreciate
4. D) deficits; appreciate
Answer: C
59
Under the current managed float exchange rate regime; countries with surpluses in their balance
of payments frequently do not want to see their currencies appreciate because it makes their
goods ________ expensive abroad and foreign goods ________ in their countries.
1. A) more; cheaper
2. B) more; costlier
3. C) less; cheaper
4. D) less; costlier
Answer: A
60
Under the current managed float exchange rate regime, countries with balance of payments
________ frequently do not want to see their currencies ________ because it makes foreign goods
more expensive for domestic consumers and can stimulate inflation.
1. A) surpluses; depreciate
2. B) deficits; depreciate
3. C) surpluses; appreciate
4. D) deficits; appreciate
Answer: B
61
A speculative attack involves massive sales of a currency or purchases of a currency that cause a
sharp change in the exchange rate under a exchange rate system.
1. A) weak; strong; fixed
2. B) strong; weak; fixed
3. C) weak; strong; floating
4. D) strong; weak; floating
Answer: A
62
Under the Exchange Rate Mechanism of the European Monetary System, when the British pound
depreciated below its lower limit against the German mark, the Bank of England was required to
buy ________ and sell ________, thereby ________ international reserves.
1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing
Answer: A
63
Under the Exchange Rate Mechanism of the European Monetary System, when the British pound
depreciated below its lower limit against the German mark, the German central bank was
required to buy ________ and sell ________, thereby ________ international reserves.
1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing
Answer: B
64
Under the Exchange Rate Mechanism of the European Monetary System, when the German
mark depreciated below its lower limit against the British pound, the Bank of England was
required to buy ________ and sell ________, thereby ________ international reserves.
1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing
Answer: C
65
Under the Exchange Rate Mechanism of the European Monetary System, when the German
mark depreciated below its lower limit against the British pound, the German central bank was
required to buy ________ and sell ________, thereby ________ international reserves.
1. A) pounds; marks; losing
2. B) pounds; marks; gaining
3. C) marks; pounds; gaining
4. D) marks; pounds; losing
Answer: D
66
In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to
the British pound, but it failed because participants in the foreign exchange market came to
expect the
1. A) appreciation of the mark.
2. B) depreciation of the mark.
3. C) revaluation of the dollar.
4. D) end of the Exchange Rate Mechanism.
Answer: A
67
The Policy Trilemma states that a country or a monetary union can't pursue the following three
policies at the same time
1. A) capital control, a fixed exchange rate, and an independent monetary policy.
2. B) free capital mobility, a fixed exchange rate, and an independent monetary policy.
3. C) free capital mobility, a flexible exchange rate, and an independent monetary
policy.
4. D) capital control, a flexible exchange rate, and an independent monetary policy.
Answer: B
68
China chooses to have ________ and ________ and therefore, cannot have free capital mobility at
the same time.
1. A) a fixed exchange rate; no control of monetary policy
2. B) a fixed exchange rate; an independent monetary policy
3. C) a flexible exchange rate; an independent monetary policy
4. D) a flexible exchange rate; no control of monetary policy
Answer: B
69
The United States chooses to have ________ and ________ and therefore, cannot have a fixed
exchange rate at the same time.
1. A) capital control; an independent monetary policy
2. B) free capital mobility; an independent monetary policy
3. C) free capital mobility; no control of monetary policy
4. D) capital control; no control of monetary policy
Answer: B
70
Hong Kong chooses to have ________ and ________ and therefore, cannot have an independent
monetary policy at the same time.
1. A) capital control; a fixed exchange rate
2. B) free capital mobility; a fixed exchange rate
3. C) free capital mobility; a flexible exchange rate
4. D) capital control; a flexible exchange rate
Answer: B
71
Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed
exchange rate system. What alternative policies are available to eliminate the overvaluation of
the exchange rate?
Answer: See Chapt. 18 number 71
The par value is above the equilibrium value, resulting in overvaluation of the exchange rate.
One approach is to pursue contractionary monetary policies, raising interest rates and increasing
the demand for domestic assets. This process continues until equilibrium at par value is
restored. Another alternative is for the central bank to purchase domestic currency by selling
foreign assets.
72
Assume that a fixed exchange rate is overvalued. Describe the situation of a speculative crisis
against this currency. What can the central bank do to defend the currency? Why might the
alternative of devaluation be preferable?
Answer: When the speculative attack begins, the expected depreciation of the domestic currency
increases substantially, decreasing the demand for domestic assets. Contractionary monetary
policy is needed to increase domestic interest rates enough to defend the currency. The cost to
the central bank in terms of the costs of intervention and the contractionary effect on the
economy may make devaluation preferable.
73
A capital ________ can promote financial instability in an emerging-market country because it is
what forces a country to ________ its currency.
1. A) inflow; devalue
2. B) inflow; revalue
3. C) outflow; devalue
4. D) outflow; revalue
Answer: C
74
A capital ________ can promote financial instability in an emerging-market country because it can
lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a
________.
1. A) inflow; financial crisis
2. B) inflow; currency devaluation
3. C) outflow; financial crisis
4. D) outflow; currency devaluation
Answer: A
75
A case for capital inflow controls can be made because capital inflows
1. A) can cause a lending boom and lead to excessive risk taking.
2. B) never finance productive investments.
3. C) always finance productive investments.
4. D) are less likely to cause financial crises than regulation of banking activities.
Answer: A
76
Which of the following is NOT a disadvantage of controls on capital outflows?
1. A) The controls may lead to excessive risk taking by the domestic banks.
2. B) They are seldom effective during a crisis.
3. C) Capital flight may increase after they are put in place.
4. D) Controls often lead to an increase in government corruption.
Answer: A
77
This agency acts like an international lender of last resort to cope with financial instability.
1. A) World Bank
2. B) European Central Bank
3. C) IMF
4. D) International Bank for Reconstruction and Development
Answer: C
78
An international lender of last resort creates a serious ________ problem because depositors and
other creditors of banking institutions expect that they will be protected if a crisis occurs.
1. A) moral hazard
2. B) adverse selection
3. C) public choice
4. D) strategic choice
Answer: A
79
An international lender of last resort creates a serious moral hazard problem because ________
and other ________ of banking institutions expect that they will be protected if a crisis occurs.
1. A) depositors; debtors
2. B) depositors; creditors
3. C) borrowers; debtors
4. D) borrowers; creditors
Answer: B
80
In the early 1970s, the U.S. ran large balance of payments ________, causing an ________ dollar and
an ________ German mark.
1. A) deficits; undervalued; overvalued
2. B) deficits; overvalued; undervalued
3. C) surpluses; undervalued; overvalued
4. D) surpluses; overvalued; undervalued
Answer: B
81
In response to the overvalued dollar in the early 1970s, the German Bundesbank bought ________
and sold ________ to keep the exchange rate fixed, gaining international reserves.
1. A) marks; dollars
2. B) marks; pounds
3. C) dollars; marks
4. D) dollars; pounds
Answer: C
82
In response to the overvalued dollar in the early 1970s, the German Bundesbank bought dollars
and sold marks to keep the exchange rate fixed, gaining international reserves. The huge
purchase of international reserves meant that the German monetary base began to ________,
leading to ________ growth in the German money supply.
1. A) decline; sluggish
2. B) decline; rapid
3. C) grow; sluggish
4. D) grow; rapid
Answer: D
83
The German central bank gained international reserves in the early 1970s because it sold ________
to prevent mark ________.
1. A) marks; appreciation
2. B) dollars; appreciation
3. C) marks; depreciation
4. D) dollars; depreciation
Answer: A
84
Since the abandonment of the Bretton Woods system, balance of payments considerations have
become ________ important, and exchange rate considerations ________ important in the conduct
of monetary policy.
1. A) more; less
2. B) more; more
3. C) less; less
4. D) less; more
Answer: D
85
If a central bank does not want to see its currency fall in value, it may pursue ________ monetary
policy to ________ the domestic interest rate, thereby strengthening its currency.
1. A) expansionary; raise
2. B) contractionary; raise
3. C) expansionary; lower
4. D) contractionary; lower
Answer: B
86
If a central bank does not want to see its currency ________ in value, it may pursue contractionary
monetary policy to raise the domestic interest rate, thereby ________ its currency.
1. A) fall; strengthening
2. B) fall; weakening
3. C) rise; strengthening
4. D) rise; weakening
Answer: A
87
If a central bank does not want to see its currency rise in value, it may pursue ________ monetary
policy to ________ the domestic interest rate, thereby weakening its currency.
1. A) expansionary; raise
2. B) contractionary; raise
3. C) expansionary; lower
4. D) contractionary; lower
Answer: C
88
If a central bank does not want to see its currency ________ in value, it may pursue expansionary
monetary policy to lower the domestic interest rate, thereby ________ its currency.
1. A) fall; strengthening
2. B) fall; weakening
3. C) rise; strengthening
4. D) rise; weakening
Answer: D
89
If a central bank does not want to allow the domestic currency to appreciate, it will ________
international reserves by selling its currency, thereby ________ the monetary base and increasing
the risk of higher inflation.
1. A) lose; decreasing
2. B) lose; increasing
3. C) acquire; decreasing
4. D) acquire; increasing
Answer: D
90
If a central bank does not want to allow the domestic currency to depreciate, it will ________
international reserves by purchasing its currency, thereby ________ the monetary base and
increasing the risk of higher unemployment.
1. A) lose; decreasing
2. B) lose; increasing
3. C) acquire; decreasing
4. D) acquire; increasing
Answer: A
91
A central bank's attempt to prevent an appreciation of its currency can stimulate domestic
inflation if the ________ of its currency leads to ________ international reserves which ________ the
monetary base.
1. A) purchase; higher; increases
2. B) purchase; lower; decreases
3. C) sale; lower; decreases
4. D) sale; higher; increases
Answer: D
92
A central bank's attempt to prevent an appreciation of its currency can stimulate domestic
inflation if the ________ of foreign currencies leads to ________ international reserves which
________ the monetary base.
1. A) purchase; higher; increases
2. B) purchase; lower; decreases
3. C) sale; lower; decreases
4. D) sale; higher; increases
Answer: A
93
To keep from running out of international reserves under the Bretton Woods system, a country
had to implement ________ monetary policy to ________ its currency.
1. A) expansionary; strengthen
2. B) expansionary; weaken
3. C) contractionary; strengthen
4. D) contractionary; weaken
Answer: C
94
Under the Bretton Woods system, when a country adopted an expansionary monetary policy,
thereby causing a balance of payments ________, the country would eventually be forced to
implement ________ monetary policy.
1. A) deficit; expansionary
2. B) deficit; contractionary
3. C) surplus; expansionary
4. D) surplus; contractionary
Answer: B
95
Because the United States was the reserve-currency country under the Bretton Woods system, it
could run large balance of payments ________ without ________ significant amounts of
international reserves.
1. A) deficits; losing
2. B) deficits; gaining
3. C) surpluses; losing
4. D) surpluses; gaining
Answer: A
96
A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a
currency to the currency of a large, low inflation country is called ________ targeting.
1. A) exchange-rate
2. B) currency
3. C) monetary
4. D) inflation
Answer: A
97
Under an exchange-rate targeting rule for monetary policy, a crawling peg
1. A) fixes the value of the domestic currency to a commodity such as gold.
2. B) fixes the value of the domestic currency to that of a large, low-inflation country.
3. C) allows the domestic currency to depreciate at a steady rate so that inflation in
the pegging country can be higher than that of the anchor country.
4. D) allows the domestic currency to depreciate at a steady rate so that inflation in
the pegging country can be lower than that of the anchor country.
Answer: C
98
An advantage to exchange-rate targeting is it helps keep inflation under control by tying the
inflation rate for ________ traded goods to what is found in the ________ country.
1. A) domestically; anchor
2. B) domestically, domestic
3. C) internationally; anchor
4. D) internationally; domestic
Answer: C
99
Exchange-rate targeting allows a central bank to ________, thus this will ________ the probability of
policy developing a time-inconsistency problem.
1. A) be governed by a policy rule; decrease
2. B) follow discretionary policy; decrease
3. C) be governed by a policy rule; increase
4. D) follow discretionary policy; increase
Answer: A
100
Which of the following is NOT an advantage to exchange-rate targeting?
1. A) It provides a strong nominal anchor to keep inflation under control.
2. B) It provides an automatic rule for policy to help avoid the time-inconsistency
problem.
3. C) It is simple and clear so that the public can easily understand it.
4. D) It increases the accountability of policymakers.
Answer: D
101
Under exchange-rate targeting, the central bank in the targeting country ________ lose the ability
to pursue its own independent monetary policy and any shocks to the anchor country is ________
transmitted to the targeting country.
1. A) does; directly
2. B) does not; directly
3. C) does; not directly
4. D) does not; not directly
Answer: A
102
Both France and the United Kingdom successfully used exchange-rate targeting to lower
inflation in the late 1980s and early 1990s by tying the value of their currencies to the
1. A) U.S. dollar.
2. B) German mark.
3. C) Swiss franc.
4. D) Euro.
Answer: B
103
Which of the following is NOT a disadvantage of exchange-rate targeting?
1. A) It relies on a stable money-inflation relationship.
2. B) The targeting country gives up an independent monetary policy.
3. C) The targeting country is left open for a speculative attack.
4. D) It can weaken the accountability of policymakers.
Answer: A
104
Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the
country ________ conduct successful monetary policy on its own, and if the country wants to
________ integration of the domestic economy with its neighbors.
1. A) cannot; encourage
2. B) cannot; discourage
3. C) can; encourage
4. D) can; discourage
Answer: A
105
An emerging market country that successfully used exchange-rate targeting to lower its inflation
from above 100 percent in 1988 to below 10 percent in 1994 (before devaluation) was
1. A) Thailand.
2. B) Mexico.
3. C) The Philippines.
4. D) Indonesia.
Answer: B
106
Because many emerging market countries have not developed the political or monetary
institutions that allow the successful use of discretionary monetary policy
1. A) they have little to gain from pegging their exchange rate to an anchor country
like the U.S. or Germany.
2. B) they have little to gain from using a nominal anchor, because it would mean a
monetary policy that is overly expansionary.
3. C) they have very little to gain from an independent monetary policy, but a lot to
lose.
4. D) they would be better off giving their central bankers the independence to use
discretion, rather than take their discretion away through any nominal anchor.
Answer: C
107
When a domestic currency is completely backed by a foreign currency and the note-issuing
authority establishes a fixed exchange rate to this foreign currency, then the country is said to
have
1. A) created a currency board.
2. B) undergone dollarization.
3. C) adopted a managed exchange system.
4. D) adopted an exchange rate monetary system.
Answer: A
108
When a country forgoes its own currency and starts using another country's currency as its own,
we say that this country has
1. A) created a currency board.
2. B) undergone dollarization.
3. C) adopted a managed exchange system.
4. D) adopted an exchange rate monetary system.
Answer: B
109
The revenue a government gains from issuing money is
1. A) interest.
2. B) rent.
3. C) seignorage.
4. D) the national dividend.
5. E) the inflation tax.
Answer: C
110
A country that dollarizes
1. A) maximizes its seignorage.
2. B) earns the same amount of seignorage as it would with a currency board.
3. C) earns the same amount of seignorage as it would with exchange-rate targeting.
4. D) eliminates its seignorage.
5. E) must pay seignorage to other governments to use their currency.
Answer: D
111
The seignorage for a government is greater for ________ than for ________.
1. A) dollarization; a currency board
2. B) dollarization; exchange-rate targeting
3. C) dollarization; monetary targeting
4. D) dollarization; inflation targeting
5. E) exchange-rate targeting; dollarization
Answer: E
112
The monetary policy strategy that provides an automatic rule for the conduct of monetary policy
is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: A
113
The monetary policy strategy that does NOT allow the policy to focus on domestic
considerations is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: A
114
The monetary policy strategy that results in the loss of an independent monetary policy is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: A
115
The monetary policy strategy that directly ties down the price of internationally traded goods is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: A
116
Explain an additional disadvantage for a country undergoing dollarization compared to a
currency board or other exchange-rate targeting regimes.
Answer: The additional disadvantage to dollarization is that the government loses seignorage.
Seignorage is the income that a government earns by issuing its own currency.
117
Explain the 1992 crisis that led to the breakdown of the European Union's Exchange Rate
Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?
Answer: The 1992 crisis began with Germany raising interest rates in 1990 to stem inflationary
pressures from reunification. This demand shock was immediately transmitted to the other
nations in the exchange-rate mechanism. Thus, these countries did not have independent
monetary policies and were subject to shocks from the anchor country. This gave rise to the
second problem. Speculators bet that these other countries would not want the increased
unemployment resulting from the tight monetary policy. Betting that their commitment was
weak, speculators bet against these currencies, and a number were forced to devalue or drop
out of the ERM. The disadvantages illustrated by this are the lack of independent policy
subjecting member nations to shocks from the anchor nation, and the possibility of speculative
attacks when commitment is felt to be weak.
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